UNIVERSITY  OF  CALIFORNI 
AT   LOS  ANGELES 


FOREIGN  EXCHANGE 


'*-*•.  t 


FOREIGN  EXCHANGE 


BY 
ALBERT  C.  WHITAKER 

PROFESSOR    OF    ECONOMICS,    STANFORD    UNIVERSITY 


D.  APPLETON  AND  COMPANY 

NEW  YORK  LONDON 

1926 


78 


cor\'Ki);i'T,  5.9l|,  ay 
D.  APPLETON  AND  COMPANY 


PRINTED    IN    THE    UNITED    STATES    OF    AMERICA 


h 


HSSf 


WITH  ACKNOWLEDGMENTS 

TO 

F.  L.  LIPMAN,  E.  W.  WILSON 

AND 

L.  R.  COFER 


PREFACE 


This  book  deals,  not  with  the  subject  of  international 
trade  in  its  entirety,  but  with  the  plans  of  payment  and  the 
methods  of  banking  and  financing  followed  in  that  trade. 

J   It  treats  of  "foreign  exchange"  in  the  narrower,  and  at  the 

k»  same  time,  conventional,  sense,  as  meaning  the  commercial 
paper  of  international  trade,  or  the  checks,  drafts,   and 

^  bills  utilized  therein.  By  means  of  these  instruments,  im- 
porters and  exporters  manage,  through  the  aid  of  the  bank- 
ers for  foreign  commerce,  not  only  to  settle  their  accounts, 
that  is,  to  make  and  collect  payments,  but  also  to  finance 

i   their  shipments,  which  is  something  quite  distinct.     Stated 

■  briefly,  the  subjects  of  study  in  this  volume  are  the  methods 

or  proceedings  and  the  forms  or  documents  of  foreign-trade 

settlement,  banking,  and  financing.     Belonging  with  these, 

the  international  movement  of  gold  and  the  measures  taken 

^  to  influence  it  are  examined  at  length.  The  contemporary 
expansion   of  American   foreign  trade   and  the   entry  of 

^American  banks  into  the  foreign  field  adds  much  to  the 
importance  of  these  matters  with  us  to-day. 

It  is  hoped  the  book  will  prove  useful,  not  only  to  those 
following  foreign  trade  and  banking  as  business  call- 
ings, but  to  all  students  of  the  questions  of  national  policy 
that  arise  out  of  foreign  commerce.  In  its  endeavor  to 
serve  the  former,  the  volume  presents  itself  as  a  practical 
business  manual,  while  to  the  latter  it  comes  as  a  treatise  in 
economics.  The  union  of  these  two  has  not  appeared  in 
the  end  to  be  detrimental  to  either.  Most  that  is  told  herein 
is  worth  the  economisl  's  knowing,  and  in  any  case  the  or- 

vii 


-~ 


mii  PREFACE 

ganization  is  such  that  sections  dealing  with  matters  of  an 
over-technical  character  may  readily  be  omitted.  It  is  par- 
ticularly desired  thai  this  work  should  find  employment  as 
a  text  in  a  full  and  independent  course  on  foreign  exchange 
in  university  departments  of  economics  or  of  commerce  and 
business  administration,  where  heretofore  the  subject  has 
usually  been  handled  in  an  incidental  way  in  the  general 
course  or  in  the  course  on  money  and  banking.  As  a  busi- 
ness manual  the  book  in  no  wise  sets  up  the  claim  that  it 
will  give  a  complete  practical  education  to  the  one  who  is  to 
enter  the  field  of  business  of  which  it  treats.  For  any  book 
to  make  such  a  claim  would  be  tantamount  to  a  jest.  What 
it  should  do  is  to  enable  the  one  who  studies  it  to  profit  most 
from  the  lessons  of  experience,  his  real  teacher. 

A.  C.  W. 


CONTENTS 

CHAPTEH  PAGE 

I.  Means  of  Payment  and  Commercial  Paper  ....  1 

1.  Subject  and  plan  of  the  book 1 

2.  Money  and  means  of  payment 2 

3.  Legal  tender 6 

4.  Commercial   paper 9 

5.  The  bill  of  exchange 11 

6.  The  acceptance 15 

7.  The  note 17 

8.  Checks,  drafts,  and  exchange 20 

II.  The  Negotiability  of  Commercial  Paper     ....  22 

9.  Negotiability 22 

10.  The  defenses  against  payment  of  negotiable  in- 

struments       24 

11.  Negotiation 26 

12.  The  liability  of  parties 29 

III.  Discount  and  Interest 39 

13.  Future  sum  and  present  price 39 

14.  The  rate  of  discount  and  the  rate  of  interest  .      .  43 

15.  Illustrative  problems 45 

16.  The  terminology  of  discount  and  interest             .  52 

17.  Discount  conceived  of  as  interest  in  advance     .  53 

IV.  Commercial   Banking 56 

18.  The  functions  of  the  commercial  bank       .      .      .  56 

19.  Deposits  and  reserve 57 

20.  The  loans  and  their  limits 58 

V.  The  Kates  of  Exchange 62 

21.  The  general  character  of  dealings  in  exchange     .  62 

22.  The  methods  of  quoting  a  rate  of  exchange    .      .  73 

23.  Specimen  market  reports 74 

24.  Comment  and  explanations 78 

25.  The  classes  of  exchange  quoted 84 

26.  The  telegraphic  transfer  or  cable si' 

27.  Sterling  rates 90 

28.  The  rates  on  France 92 

29.  The  rates  on  Germany  and  other  countries     .      .  95 

ix 


jv/ 


x  CONTENTS 

CHAPTER  PAGE 

VI.  The  Documentary  Trade  Bill 98 

30.  The  documentary  bill  of  exchange &8 

31.  The  bill  of  lading 102 

32.  The   insurance  certificate 106 

33.  The   hypothecation    certificate   and   other   docu- 

ments          107 

34.  The  documentary  instructions 117 

35.  Prepayment  and  the  retirement  rate  of  discount  119 

36.  The  actual  mercantile  receipts  for  and  costs  of 

the  goods 123 

VII.  The  Bank  Credit  and  Letter  of  Credit 131 

37.  The  nature  of  the  commercial  credit  .      .      .      .131 

38.  The  grant  by  one  bank  of  the  right  to  draw  on 

another    bank 133 

39.  How  merchants  make  use  of  commercial  credits  .    136 

40.  Banking  operations  involved  and  the  acceptance 

account 141 

41.  The  contract  for  a  letter  of  credit 148 

42.  The  banker's  legal  interest  in  the  merchandise  .  152 

43.  Kelease    of    the    goods    to    the    importer.     The 

"trust  receipt" 154 

44.  The  bank  credit  as  a  means  of  financing  a  ship- 

ment     160 

45.  The  risk  of  exchange 164 

46.  Advantages  of  the  letter  of  credit  system  sum- 

marized      167 

47.  The  confirmed   credit 169 

48.  The  "authority  to  purchase"  and  "authority  to 

draw" 171 

49.  The  practical  nature  of  the  right  of  recourse     .    176 

50.  The  commissions  charged  for  bank  credits     .      .    179 

51.  The  traveler's  letter  of  credit  and  the  traveler's 

cheque 181 

VIII.  Foreign  Money  Market  Factors 190 

52.  The  foreign  balance 190 

53.  The  services  and  compensation  of  correspondent 
banks         199 

54.  The  dealers  in  money  in  the  London  market:  the 
joint  stock  banks 207 

55.  The  bill  brokers  and  discount  houses  ....   218 

56.  The  branches  of  foreign  and  colonial  banks    .      .   227 

57.  The  Bank  of  England 231 

58.  The  bank  rate 237 

59.  Kediscounting  at  the  bank  in  times  of  stringency  244 

60.  Interest  and  discount  rates  customarily  in  fixed 
relation  with  the  bank  rate 250 


CONTENTS  xi 

CHAPTER  PAGE 

61.  The  group  of  London  money  rates 252 

62.  The  "arrival"  discount  rate 255 

63.  Stamp    taxes 256 

IX.  The  Purchase  of   Bills  for  Direct  Credit  to  the 

Foreign  Balance 258 

64.  Buying  bankers'  long  bills 258 

65.  Buying  long  bills  drawn  by  merchants  on  banks  266 

66.  Trade  bills,  documents  for  acceptance  ....  267 

67.  Trade  bills,  documents  for  payment   ....  268 

68.  Selling  sight  drafts  and  cables 271 

X.  Dealings  of  a  More  Involved  Character     ....  275 

69.  The   bill   drawn   on   a   foreign   country  in  home 
money 275 

70.  The  banker's  buying  price  for  such  a  bill     .      .  282 

71.  The   bill   on   a   foreign   country   in  money   of   a 
third  country 284 

( 1 )  A  third  type  of  draft  on  the  importer      .  284 

(2)  The  three  national  currencies  involved      .  286 

(3)  The  disposal  of  the  return  draft     .      .      .287 

(4)  The  risks  of  exchange  and  their  incidence  288 

(5)  Computing  the  sterling  face  value  .      .      .  289 

(6)  Comparison  with  a  more  familiar  method 
of  settlement 292 

(7)  The  outcome  to  the  purchasing  banker     .  293 

(8)  Special  contracts  with  respect  to  the  risk 
of  exchange 296 

(9)  The  importer's  preference  for  the  custom- 
ary reckoning 296 

(10)  Purchasing   the   draft   on   the   basis   of   a 
discount  rate 297 

(11)  The  reason  for  sterling  drafts  on  outlying 
countries         299 

(12)  Concerning  the  use  of  a  long-term  return 
draft 300 

(13)  How   London   indirectly   finances   the   Ar- 
gentine import 303 

(14)  Instructions    as     to    drawing    on    South 
America 304 

72.  The  bill  with  an  interest  clause 306 

73.  The   "colonial   clause" 310 

74.  Settlement  without  draft  by  exporter.     Delega- 
tions      318 

75.  Advances  and  local  bank  acceptances  arranged  by 
exporter 321 

76.  Terms  and  methods  of  settlement  summarized   .  325 

77.  Dealing    in  exchange  on  places  where  no  balance 
is  kept 337 


xii  CONTENTS 

CHAPTER  PAGE 

XI.  Investment  in  Exchange 343 

7S.  Exchange    investment,    borrowing,    and    specula- 
tion        343 

79.  The  method  of  investment 344 

SO.  Computing  the  rate  of  interest  received   .            .  347 

81.  The  speculation  on  the  sight  rate  of  exchange    .  350 

82.  Termination  of  investment  prior  to  maturity     .  353 

XII.  Borrowing  by  Means  of  Exchange 359 

83.  The   "dollar"    loan   by   a   foreign   bank    in   New 

York 359 

84.  The  "sterling"   (franc  or  mark)  loan  ....  365 

85.  The  borrowing  bank's  sale  of  its  own  long  bill   .  367 

86.  The   spread   between   the   local   and   the   foreign 

money   rates 369 

87.  A  joint-account  transfer  of  loanable  funds     .      .  372 

88.  American  loans  in  foreign  monetary  capitals      .  377 

89.  Observations  on  the  "finance  bill" 378 

Xill.  Speculation  in  Exchange 381 

90.  Futures,  speculation,  and  hedging 381 

91.  Operations  in  futures  as  a  means  of  hedging     .  382 

92.  Going  long  of  exchange 3S4 

93.  Going  short  of  exchange 389 

94.  .Recovery  of  funds  laid  out  for  documentary  pay- 

ment bills 391 

XIV.  Arbitrage 397 

95.  Arbitrage    and    arbitrated    rates,    parities,    and 

prices 397 

96.  The  two  methods  of  direct  transfer  of  funds     .  404 

97.  Two-point  arbitrage 408 

98.  Methods  of  indirect  transfer  of  funds       .      .      .416 

99.  Three-point  and  more  complex  arbitrage  .      .      .  418 

100.  Arbitrage,  speculation,  and  futures     ....  423 

101.  Arbitrage  in   stocks 426 


XV.  Coinage  Laws  and  Exchange  Rates 429 

102.  The  several  monetary  standards 429 

103.  Mint  pars  of  exchange 432 

104.  Mint  pars  distinguished  from  actual  values  .      .  435 

105.  Free  and  gratuitous  coinage 437 

106.  Standard  bullion:  the  two  chief  standards    .      .  440 


XVI.  The  Mint  Price  and  the  Market  Price  of  Gold     .      .   443 

107.  The  striking  stability  of  the  market  price  of  gold  443 

108.  The  mint  price  of  standard  bullion      ....    445 

109.  The  mint  price  of  fine  bullion 446 

110.  The  market  price  of  gold 448 

111.  The  fluctuating  purchasing  power  of  gold     .      .   451 


-/>  *v  -/'  'A 


J 


CONTENTS  xiii 

CHAPTER  PAGE 

XVII.  Standard  Money 453 

112.  The  several  forms  of  money  in  a  modern  mone- 
tary system 453 

113.  Standard  and  representative  money     ....   453 

114.  Approved  characteristcs  of  standard  money  .      .   455 

115.  Commodity  and  fiat  standard  money  ....   456 

116.  Contrasts  in  respect  to  regulation  of  quantity  .   458 

117.  The  quantity  of  money  and  its  value  ....   460 

118.  The  fluctuations  of  the  value  of  gold  commodity 
money 462 

119.  The  exportability  of  commodity  money     .      .      .   463 

XVTI1.  Representative  Money 465 

120.  The  nominal  and  bullion  values  of  token  moneys  465 

121.  The   coining   value   and   market  value   of   token 
bullions 468 

122.  The   non-exportable   character   of   representative 
moneys 471 

123.  The    features    of    a    perfected    system   of    token 
money 474 

124.  The  limping  gold  standard 476 

XIX.  Monetary  Systems  of  the  Leading  Nations     .      .      .   479 

125.  Troy  and  metric  weight 479 

126.  The  standard  units  of  value 481 

127.  Tables  of  mint  pars 484 

128.  Technical  detail.     The  United  States  .      .      .      .486 

129.  Technical  detail.     England 492 

130.  The  mint  price  of  gold  in  the  United  States  .      .   497 

131.  The  mint  and  bank  price  of  gold  in  England     .   502 

132.  The  London  market  price  for  bar  gold  and   its 
limits 507 

133.  The  mint  and  bank  price  of  gold  in  France  .      .    509 

134.  The  mint  and  bank  price  of  gold  in  Germany     .   513 

XX.  Specie    Shipments 517 

135.  The  classification  of  gold  movements  .      .      .      .517 
130.  Gold  shipments  for  a  profit 518 

137.  The  gold  points 522 

138.  Gold    export,    New   York    to   London:    practical 
computations 524 

139.  Gold  import  by  New  York  from  London  .  .   531 
f    140.  The  place  of  interest  in  the  cost  of  gold  move- 

\\j        /  ments .536 

\  /      141.  Variant    methods    of    calculating    the    interest 

charge 530 

142.  The  gold  points  and  the  mint  par  .      .             .       .  5  42 

143.  Special  banking  methods  of  influencing  the  gold 
movemenl 544 

144.  Manipulation  of  the  discount  rate 546 


xiv  CONTENTS 

CHAPTER  PAGE 

145.  Manipulation  of  the  price  of  gold 556 

146.  The  gold-premium  policy  of  the  Bank  of  France  563 

147.  Further  methods  of   influencing  the  gold  move- 
ment      571 

•^XXl.  The  Theory  of  the  Exchange  Kates 578 

148.  Supply  and  demand  and  the  rate 578 

149.  The  manner  in  which  "supply  and  demand  regu- 

lates"  a   rate 582 

150.  Interpretation  of  apparent  contradictions      .      .  5S3 

151.  The  sources  of  exchange  supply  and  demand  .      .  588 

152.  How  national  credits  and  debits  affect  the  market  592 

153.  The  several  spreads  in  the  group  of  rates  on  a 

given  country 596 

154.  The  spreads  for  the  long  rates 599 

155.  The  telegraphic  transfer  spread 601 

156.  Arbitrage  and  the  interrelation  of  rates   .      .      .611 

157.  The  international  distribution  of  gold       .      .      .  618 

Addendum.    The  Question  of  Dollar  Exchange      ....  624 


FOREIGN  EXCHANGE 


FOREIGN  EXCHANGE 

CHAPTER  I 
MEANS   OF   PAYMENT   AND    COMMERCIAL   PAPER 

§  1.  The  subject  and  plan  of  the  book. — The  word  "ex- 
change ' '  is  used  in  a  broad  sense  as  a  synonym  for  trade  or 
commerce.  It  also  signifies  a  place  or  building  where  a 
particular  kind  of  trade  is  carried  on,  as  a  stock  exchange 
or  a  cotton  exchange.  The  word  has  still  another  meaning, 
the  meaning  for  example  which  attaches  to  it  in  such 
phrases  as  "New  York  exchange"  or  "sterling  exchange." 
Here  it  refers  to  that  class  of  written  orders  to  pay  money, 
known  legally  as  bills  of  exchange,  drawn  by  merchants  or 
bankers  at  one  geographical  point  upon  those  at  other 
points,  which  are  used  so  much  oftener  than  money  itself 
as  a  means  of  making  payments  or  settling  indebtedness 
between  distant  places.  In  good  usage,  "exchange"  has 
come  to  have  only  this  special  and  narrow  banking  significa- 
tion when  it  appears  in  the  phrase  "foreign  exchange." 
That  is,  "foreign  exchange"  does  not  usually  mean  inter- 
national trade.  Thus  it  comes  to  pass  that  this  book,  like 
others  on  the  subject  of  foreign  exchange  or  the  foreign 
exchanges,  is  not  occupied  with  international  commerce  in 
general,  but  merely  with  one  of  its  incidents,  namely,  the 
system  by  means  of  which  the  world  of  business  discharges 
the  debts  that  arise  out  of  this  commerce.  In  a  word,  it  is 
devoted  to  the  subject  of  international  means  of  payment. 
It  will  be  the  endeavor  to  combine  in  the  present  work  a 

l 


2  FOREIGN  EXCHANGE 

practical  business  manual  and  a  treatise  in  political 
economy.  The  distinctive  object  of  the  business  manual 
pure  and  simple  is  to  aid  in  the  development  of  individual 
business  proficiency,  while  the  distinctive  object  of  a  study 
in  economics  is  to  throw  light  upon  questions  of  the  public 
policy  of  the  state  or  nation.  It  seems  feasible  in  the 
undertaking  in  hand  to  serve  the  two  purposes  conjointly. 
As  an  economic  treatise  on  the  exchanges  this  book  aims  to 
unfold  the  principles  in  accordance  with  which  this  part  of 
the  business  system  operates.  The  result  of  this  study, 
or  of  other  similar  studies,  should  constitute  a  section  of 
our  general  economic  knowledge — a  section  which  would  be 
relatively  unimportant  in  connection  with  many  questions 
but  significant  to  a  high  degree  in  connection  with  prob- 
lems of  public  monetary  and  banking  policy,  and  to  a  cer- 
tain degree  in  connection  with  questions  of  tariff  policy. 
The  endeavor  to  make  the  book  a  useful  business  manual 
necessitates  the  treatment  of  banking  and  business  forms 
and  procedure  with  much  particularity.  But  there  can 
be  little  question  of  the  advantage  to  the  economist,  even 
as  publicist,  of  knowledge  of  the  business  detail  of  banking 
for  foreign  trade,  and  of  the  exchanges  and  specie  move- 
ments. On  the  other  hand,  an  attempt  to  explain  the  sys- 
tem of  the  foreign  exchanges  after  the  fashion  of  the  econ- 
omists, should  exert  a  beneficial  influence  upon  the  book  as 
a  business  manual. 

§  2.  Money  and  means  of  payment. — In  the  ordinary 
business  transaction  of  purchase  and  sale,  we  think  of  the 
buyer  as  being  obligated  to  make  payment  to  the  seller  in 
money.  But  in  fact  he  frequently  settles  without  the  use 
of  actual  money,  finding  it  more  convenient  to  employ 
other  means  of  payment.  In  truth,  his  obligation  cannot 
be  described  exactly  as  one  to  pay  money.  The  strict  legal 
obligation  of  the  buyer  of  goods  for  "money,"  that  is,  the 
buyer  at  an  ordinary  price  without  special  stipulations  as 


MEANS  OF  PAYMENT  AND  COMMERCIAL  PAPER     3 

to  the  means  of  payment,  is  to  pay  what  is  known  as  legal 
tender.  And  only  some  of  the  things  that  are  regularly 
known  as  money  are  also  legal  tender.  In  the  United 
States,  for  instance,  gold  coin  is  both  legal  tender  and 
money,  while  bank  notes  and  silver  certificates  are  not 
legal  tender  although  they  are  undoubtedly  money.  We 
shall  speak  of  legal  tender  in  the  third  section. 

The  term  "money"  has  a  somewhat  variable  meaning, 
depending  on  context,  whether  in  legal,  economic,  or  popu- 
lar usage.  Even  the  formal  or  set  definitions  given  by 
economic  writers  differ  in  phraseology  and  substance.  So 
it  is  not  possible  to  give  a  definition  for  which  unanimous 
assent  can  be  claimed.  But  one  can  be  framed  which  will 
correctly  describe  what  is  usually  called  money  in  every- 
day life,  and  which  will  enable  us  to  draw  the  lines  of 
demarcation  between  those  means  of  payment  employed  in 
actual  commerce  that  are  best  called  money  and  those  that 
are  not,  and  which  will  bring  out  certain  items  of  informa- 
tion worth  knowing.  We  may  then  offer  the  following: 
Money  is  that  article,  or  group  of  articles,  which  is  cus- 
tomarily passed  from  hand  to  hand  throughout  a  commu- 
nity in  payment  for  ordinary  commodities  and  services, 
thus  acting  as  a  medium  for  exchanging  these  commodities 
and  services,  (1)  that  is  regularly  taken  by  the  person  who 
receives  it  without  the  intention  of  applying  it  to  any  other 
use  than  in  turn  to  offer  it  in  payment  to  others,  and  (2) 
that  is  customarily  received  without  assay  or  other  special 
test  of  its  quality  or  quantity,  and  (3)  that  is  received 
without  reference  to  or  reliance  upon  the  personal  credit 
of  the  one  who  offers  it.1 

i  Substantially  this  definition  may  be  found  in  Francis  A. 
Walker's  "Money,"  p.  395 ;  and  in  an  article  by  A.  P.  Andrew, 
Quarterly  Journal  of  Economics,  vol.  13,  p.  219;  and  in  a  decision 
of  court  in  Moss  v.  Hancock,  [1899],  2  Q.  B.  116,  cited  in  the  ar- 
ticle on  Money  in  the  "American  and  English  Encyclopedia  of  Law," 


FOREIGN  EXCHANGE 


Chief  Means  of  Payment  in  the  United  States 

Legal  tender 
powers    between 
private  persons 


Bullion 

r 

but  not 

Gold  bullion 

Full 

money 

[ 

'U.  S.  gold  coin 

Full 

XJ.  S.  silver  dollar 

Full2 

U.  S.  "subsidiary  silver"  coin 

Up  to  $10  3 

U.  S.  "minor  coin"  (5c,  lc) 

Up  to  25c3 

U.  S.  gold  certificates 

None 

Money 

U.  S.  silver  certificates 

U.    S.    treasury    notes     (green- 

None 

backs) 

Full2 

National  bank  notes 

None 

Federal  Reserve  Bank  notes 

None 

Federal  Reserve  notes 

None 

Commercial 
paper 


Cashiers'  and  certified  checks  of 
banks,  and  certificates  of  de- 
posit None 
Bankers'  drafts  on  other  banks  None 
Drafts   of   merchants   on    banks 

under  letters  of  credit  None 

Depositors'  checks  on  banks  None 

Merchant's  drafts  on  merchants         None 


vol.  20,  p.  838.  It  is  not  to  be  inferred  that  there  is  any  single 
authoritative  definition  of  money  in  a  legal  sense.  What  the  term 
is  construed  to  mean  when  occurring  in  indictments  or  documents 
which  appear  in  civil  cases,  depends  on  the  circumstances.  See 
the  word  "money"  in  "Words  and  Phrases  Judicially  Denned." 

2  Silver  dollars  and  greenbacks  are  legal  tender  in  unlimited 
amounts  in  a  single  payment  "unless  otherwise  specified  in  the  con- 
tract."    See  the  text,  p.  8,  and  note  at  end  of  §  3. 

3  Subsidiary  silver  is  legal  tender  not  to  exceed  $10  in  a  single 
payment.  Minor  coin  is  legal  tender  in  single  payments  not  to 
exceed  25c. 


MEANS  OF  PAYMENT  AND  COMMERCIAL  PAPER  5 

The  tabulation  opposite  shows  the  chief  means  of  pay- 
ment in  use  in  the  United  States  and  indicates  which  are 
money. 

While  gold  bullion  is  sometimes  referred  to  as  the  ' '  inter- 
national money"  par  excellence,  it  is  not  money  strictly 
speaking,  for  it  has  to  be  weighed  and  assayed  or  subjected 
to  special  tests  as  it  is  passed.  It  is  the  most  important 
money  material  and  is  the  practically  final  means  of  pay- 
ment between  different  countries,  including  many  countries 
not  on  the  gold  standard.  It  has  the  important  peculiarity 
of  having  a  virtually  invariable  money  price  per  ounce  (or 
other  physical  unit)  in  any  gold  standard  country  and  this 
is  what  gives  it  its  primacy  as  a  means  of  international  pay- 
ment. Commercial  paper  or  negotiable  instruments  are  es> 
eluded  from  the  category  of  money  on  the  grounds  that  these 
means  of  payment  regularly  involve  the  right  of  "personal 
recourse"  4  of  the  receiver  upon  the  giver.  In  other  words, 
they  are  taken  with  strict  reference  to  the  personal  credit 
of  those  who  have  created  them  and  who  have  handled 
them  before  they  come  to  the  one  receiving  them.  They 
do  not  have  the  universal  acceptableness  of  those  things  that 
are  truly  money,  and  this  is  clearly  the  reason  why  they 
are  not  regarded  as  money  by  people  general^.  That  these 
instruments  are  always  orders  or  promises  to  pay  some- 
thing else  is  not  the  ground  for  excluding  them  from  the 
category  of  money.  Most  forms  of  money  are  themselves 
orders  or  promises  to  pay  something  else,  for  instance,  gold 
certificates,  silver  certificates,  bank  notes,  treasury  notes,  or 
even  token  coin.5  Efforts  to  confine  the  term  "money"  to 
the  ultimate  money  of  redemption,  namely,  that  article 
which  is  not  itself  redeemable  in  anything  else,  as  gold 

*  See  later,  p.  32  et  seq. 

5  Token  coins  generally  throughout  the  world  arc  convertible 
into  standard  money,  and  may  be  looked  upon  as  metallic  orders  or 
promises  to  pay  standard  money. 


G  FOREIGN  EXCHANGE 

coin  in  a  gold  standard  country,  or  to  confine  it  to  coin,  give 
definitions  that  have  little  utility  and  no  correspondence 
■with  the  usage  of  daily  life. 

§  3.  Legal  tender. — Legal  tender  may  be  defined  as  any 
article  or  medium  which  the  law  declares  capable  of  dis- 
charging an  obligation  to  pay  money.  This  applies  to  obli- 
gations expressed  in  the  national  "unit  of  value,"  as  dollars 
in  the  United  States  and  pounds  in  England.  Person  A 
may  be  under  oral  or  written  engagement  to  pay  a  legally 
determinate  amount  of  money  to  B,  their  understanding 
being  no  more  definite  as  regards  the  medium  of  payment 
than  that  "money"  is  due;  and  A  and  B  may  have  a  dis- 
pute, at  the  time  when  A  proffers  payment,  with  respect 
to  the  medium  in  which  A  has  a  right  to  discharge  his  debt. 
To  meet  the  necessities  of  such  cases  the  law  has  provided 
what  the  things  shall  be  that  are  capable  of  discharging 
obligations  between  private  persons  expressed  in  money. 
However,  the  law  (the  reference  here  being  to  the  law  of 
England  and  the  United  States)  does  not  call  these  things 
"money,"  or  "legal  money,"  or  "lawful  money,"6  but  it 
calls  them  legal  tender.7 

If  a  creditor  for  money  refuses  to  take  legal  tender 
proffered  by  the  debtor  when  an  account  is  due,  the  effect 
of  the  proffer,  or  "tender,"  is  not  to  discharge  the  debt 
itself.  That  is,  a  rejected  tender  is  not  equivalent  to  pay- 
ment.    The  effect  is,  however,  to  stop  interest  running  on 


e  The  term  "lawful  money"  does  not  have  an  invariable  legal  sig- 
nificance in  the  United  States.  It  generally  means  any  form  of 
money  issued  by  the  United  States,  but  its  meaning  in  legal  docu- 
ments and  statutes  depends  on  context.  It  is  sometimes  used  as 
a  synonym  for  legal  tender.  See  "Words  and  Phrases  Judicially 
Defined,"  p.  4031. 

7  Countries  with  other  legal  systems  than  that  of  England,  have 
what  correspond  to  our  laws  of  legal  tender  though  they  are  not 
wholly  similar  in  nature. 


MEANS  OF  PAYMENT  AND  COMMERCIAL  PAPER  7 

the  debt  and  to  relieve  the  debtor  of  liability  for  costs  of 
collection.  "A  legal  tender  [tender  is  here  used  in  the 
sense  of  the  act  of  proffering]  is  equivalent  to  payment  as 
to  all  things  that  are  incidental  or  consequential  to  the 
debt.  The  creditor,  while  not  losing  his  rights  to  the  prior 
debt  itself  by  refusal  of  the  tender,  loses  all  collateral 
benefit  and  securities"  ("Words  and  Phrases  Judicially 
Denned,"  p.  6910). 8  In  the  event  that,  after  his  rejection 
of  the  tender,  the  creditor  later  sues  the  debtor,  the  latter 
may  plead  in  court  that  he  has  already  made  a  tender  and 
accompany  this  plea  with  a  renewed  offer  to  the  court  of 
the  original  sum  due,  and  may  thus  escape  the  necessity 
of  paying  either  costs  or  interest  after  the  date  of  the 
original  tender.  To  operate  in  this  manner  as  a  means  of 
saving  interest  and  costs,  a  tender  must  be  "kept  good," 
that  is,  the  debtor  must  not  allow  the  creditor  to  make 
a  demand  on  him  without  being  ready  with  a  proffer  of 
legal  tender.  The  refusal  of  a  creditor  to  accept  an  offered 
payment,  though  doubtless  exceedingly  rare,  might  arise 
out  of  a  dispute  over  the  medium  in  which  payment  is 
to  be  made,  or  might  be  occasioned  by  the  creditor's  suspi* 
cion  of  a  particular  kind  of  money,  or  b}'  special  circum- 
stances or  captious  motives.  In  any  case,  the  creditor  for 
money  is,  without  prejudice  to  his  rights,  entitled  to  re- 
fuse to  receive  in  payment  checks  or  drafts  or  forms  of 
money  not  legal  tender.  A  method  available  to  a  debtor 
finally  to  rid  himself  of  his  obligation,  after  a  rejected 
legal  tender,  is  to  pay  the  original  sum  due  as  on  the 
maturity  date,  into  court  for  the  account  of  the  creditor. 
Payment  into  the  creditor's  bank  for  his  account  would 
suffice  in  some  states. 

The  original  and  proper  reason  for  the  existence  of  the 

s  Compare  also  article  on  "Payment"   in  the  "American  and  Eng- 
lish  Encyclopedia  of  Law,"  vol.  22,   p.  538. 


8  FOREIGN  EXCHANGE 

law  of  legal  tender  is  that  it  is  a  technical  legal  necessity 
for  the  discharge  of  certain  kinds  of  private  contracts. 
However,  in  many  instances,  where  a  state  has  conferred 
the  legal  tender  power  upon  its  paper  money,  the  motive 
has  been  not  so  much  to  accommodate  private  citizens  with 
another  means  of  payment,  as  to  aid  in  forcing  the  circula- 
tion of  the  paper  for  the  benefit  of  the  state's  own  finances. 

As  appears  in  the  table,  there  are  but  four  forms  of 
money  in  the  United  States  which  have  "full  legal  tender 
power,"  which  means  legal  tender  power  between  private 
parties  in  unlimited  amounts  in  single  payments.  These 
are  (1)  gold  coin,  (2)  silver  dollars,  (3)  United  States  notes 
or  greenbacks,  and  (4)  gold  certificates.  Subsidiary  silver 
and  minor  coin  have  limited  legal  tender  power.9  Other 
forms  of  money  have  special  tender  -powers  of  one  sort  or 
another  in  considerable  variety.  To  give  one  example, 
a  national  bank  note  is  legal  tender  in  payment  of  an  ob- 
ligation due  any  national  bank,  whether  the  bank  that  is- 
sued the  note  or  any  other  national  bank.  Several  forms 
of  money  are  special  legal  tender  in  payment  of  taxes  and 
dues  owing  to  the  Federal  government  itself. 

"Where  a  contract  for  the  payment  of  money  expressly 
provides  for  payment  in  a  particular  kind  of  money,  the 
debtor  cannot  discharge  his  obligation  (unless  with  the 
consent  of  the  creditor)  in  any  other  form  of  money  than 
that  specified.  Thus  a  note  "payable  in  United  States  gold 
coin"  cannot  be  discharged  by  the  payment  of  silver  dollars 
or  greenbacks  except  by  the  consent  of  the  creditor.  Under 
the  present  monetary  conditions  of  the  United  States,  the 
only  form  of  contract  for  a  special  kind  of  money  which 
is  at  all  common,  is  one  calling  for  payment  "in  United 
States  gold  coin."  But  the  principle  of  law  that  a  binding 
contract  may  be  made  for  any  special  form  of  money  is 

9  See  notes  to  table  of  means  of  payment. 


MEANS  OF  PAYMENT  AND  COMMERCIAL  PAPER  9 

general  in  character  and  does  not  apply  merely  to  gold.10 

§  4.  Commercial  paper. — In  practice  sellers  of  goods  and 

creditors  in  general  almost  never  stand  upon  their  strict 

legal  rights  to  demand  legal  tender,  or  gold  coin  if  the 


10  See  the  "American  and  English  Encyclopedia  of  Law,"  article 
on  "Payment,"  vol.  22,  p.  541,  and  cases  cited  there.  After  the 
decision  of  the  United  States  Supreme  Court  in  Bronson  vs.  Rhodes, 
referred  to  beneath,  the  Federal  statute  reestablishing  the  coinage 
of  the  silver  dollar  (the  Act  of  Feb.  28,  1878,  known  as  the  "Bland- 
Allison  Silver-Purchase  Act")  provided  in  §  1  that  all  silver  dol- 
lars coined  under  this  Act  or  heretofore  coined  by  the  United  States 
"shall  be  a  legal  tender,  at  their  nominal  value,  for  all  debts  and 
dues  public  and  private,  except  lohere  otherwise  expressly  stipu- 
lated in  the  contract."  Subsequently  the  second  silver-purchase 
Act  (the  "Sherman  Act"  of  July  14,  1890)  authorized  a  special  is- 
sue of  United  States  Treasury  Notes  to  be  used  to  purchase  silver 
bullion  for  coinage,  and  in  §  2  provided  that  "such  Treasury  notes 
shall  be  a  legal  tender,"  etc.,  "except  where  otherwise  expressly  stip- 
ulated in  the  contract."  A  later  statute  provided  for  the  retirement 
and  cancellation  of  these  "Treasury  Notes  of  1890"  and  only  a  small 
amount  remain  outstanding  to-day  (1919).  The  one  other  element 
in  the  currency  of  the  United  States,  apart  from  gold  coin,  which 
has  "full  legal  tender  power,"  consists  in  the  regular  United  States 
Notes  or  "Greenbacks."  The  clause  that  these  notes  should  be  legal 
tender  "except  where  otherwise  expressly  stipulated  in  the  contract" 
has  never  been  written  into  statute.  The  "Gold-Standard  Act"  of 
March  14,  1900,  made  no  changes  whatever  in  the  legal  tender  laws. 
The  original  Act  passed  Feb.  25,  1862,  conferring  the  legal  tender 
power  upon  these  notes  was  enacted  without  this  limiting  clause 
(see  Revised  Statutes  of  the  United  States,  §3588).  Nevertheless, 
there  is  no  question  that  these  notes  lack  legal  tender  power  for 
contracts  expressly  payable  in  gold  (or  silver,  for  that  matter). 
This  assertion  is  based  on  the  decision  in  Bronson  v.  Rhodes   (1808). 

An  excellent  note  on  "special  contracts  and  obligations  to  make 
payment  in  gold  or  silver"  in  "Lawyers'  Reports  Annotated,"  Book 
29,  pp.  512-28  (1895),  surveys  tbe  course  of  judicial  decisions  on  this 
subject.  In  Bronson  v.  Rhodes,  74  U.  S.  (7  Wall.)  258,  (1868), 
the  Supreme  Court  held  that  a  bond  expressly  payable  "in  gold  and 
silver"  could  not  be  discharged  in  legal  tender  notes  except  willi 
the  consent  of  the  creditor.      (This  bond  was   issued   in   1851,  before 


10  FOREIGN  EXCHANGE 

contract  calls  for  the  latter  form  of  payment.  But  they 
readily  take  certain  substitutes  for  these  things,  which,  by 
reason  of  their  being  convertible  into  them,  are  regarded 
as  equally  good  at  the  time  and  place.  These  substitutes 
maj'  be  forms  of  money  that  are  not  legal  tender,  or  are 
not  gold,  or  they  may  be  forms  of  commercial  paper.  The 
latter  term  may  be  said  to  cover  that  entire  mass  of  trans- 
ferable written  orders  and  promises  to  pay  money  which  we 
find  circulating  among  merchants  and  banks  as  a  means  of 
discharging  obligations  which  arise  in  commerce.  It  in- 
cludes bills,  drafts,  checks,  and  notes.11  There  are,  however, 
only  two  principal  classes  of  commercial  paper,  namely 
orders  and  promises  to  pay  money.  Those  instruments 
which  are  orders  are,  if  drawn  in  a  proper  manner,  called 
bills,  or  more  fully,  bills  of  exchange.  The  promises,  if  in 
proper  form,  are  known  as  notes,  or  more  fully,  promissory 
notes.  Checks  are  merely  a  particular  class  of  bills  of 
exchange.  An  instrument  known  as  a  draft  is  also  almost 
always  some  type  of  bill  of  exchange. 

The  volume  of  commercial  paper  in  circulation  reaches 
the  enormous  proportions  that  we  find  partly  because  of 

the  creation  of  the  legal  tender  notes,  but  this  fact  has  no  deter- 
mining influence  on  the  opinion.  This  decision  has  been  followed 
uniformly  by  the  Federal  courts  in  a  number  of  cases.  As  for  the 
decisions  of  state  courts,  where  the  contract  expresses  an  indubitable 
intention  of  the  parties  to  make  it  payable  in  gold,  or  in  silver,  all 
the  numerous  state  decisions  subsequent  to  Bronson  v.  Rhodes  follow 
it  except  two,  and  neither  of  these  are  clear  cases  (see  the  note 
above  mentioned,  p.  519). 

The  "Legal  Tender  Case"  (Knox  v.  Lee,  79  U.  S.  12  Wall. 
457)  has  been  represented  by  some  writers  as  overruling  the  doc- 
trine of  Bronson  v.  Rhodes,  but  this  representation  is  wholly  er- 
roneous  (see  same  note,  p.  518). 

n  The  term  commercial  paper  is  sometimes  used  in  a  narrower  sense 
so  as  to  exclude  drafts  drawn  by  bankers  on  bankers,  and  even  checks 
and  drafts  drawn  by  merchants  on  bankers,  but  the  better  term  to 
convey  this  narrower  meaning  would  seem  to  be  "trade  paper." 


MEANS  OF  PAYMENT  AND  COMMERCIAL  PAPER  11 

its  superior  convenience  over  money  as  a  mere  means  of 
remittance.  This  is  exemplified  by  the  great  serviceableness 
of  a  draft  on  a  New  York  bank  as  an  instrumentality  by 
means  of  which  a  merchant,  say,  in  Denver,  may  pay  an 
amount  due  to  one  in  Philadelphia  or  Boston  or  New  York. 
This  kind  of  convenience  accounts  in  general  for  the  use  of 
all  types  of  so-called  sight  or  demand  paper,  that  is  to  say, 
paper  payable  at  sight  or  on  demand.  In  great  part,  how- 
ever, the  extensive  use  of  commercial  paper  is  to  be  attrib- 
uted to  the  further  circumstance  of  the  extreme  utility  of 
time  paper,  that  is,  paper  payable  a  designated  period  after 
date  or  after  sight,  as  a  means  of  gaining  the  assistance 
of  banks  in  the  financing  of  commercial  operations  or 
operations  in  securities.  Much  of  the  present  book  will  be 
devoted  to  the  explanation  of  this  subject.  As  is  made 
clear  in  books  on  credit  and  banking,  the  effect  of  the 
employment  of  commercial  paper  as  a  substitute  for  cash  is 
not  so  much  merely  to  postpone  the  transfer  of  actual 
money  as  in  large  part  to  do  away  with  it. 

§  5.  The  bill  of  exchange. — As  already  stated  the  bill  of 
exchange  is  an  order  to  pay  money.  In  making  our  first 
acquaintance  with  this  instrument  we-  shall  be  content  to 
learn  the  rudiments  of  its  make-up  and  uses.  Discussion 
of  documentary  bills,  and  bills  under  a  bank  credit,  and 
bills  drawn  on  a  foreign  country  .payable  at  the  exchange 
rate  on  the  home  country  or  a  third  country,  and  "finance" 
bills,  and  other  such  subjects,  will  come  in  due  time.  On 
page  12  is  an  example  of  a  bill  drawn  by  merchant  on 
merchant,  a  type  sometimes  referred  to  as  a  trade  bill. 

A  legal  definition  12  of  a  bill  of  exchange  is  "an  uncoiuli- 


12  From  the  Uniform  Negotiable  Instruments  Law  (now  in  force — 
Julj',  1919 — in  all  jurisdictions  in  the  United  Slates  except  the  state 
of  Georgia),  §210,  as  the  sections  are  numbered  in  the  New  Yor^ 
law.  The  text  of  this  law  is  in  Buffcut's  "Negotiable  Instruments" 
or  in   Crawford's  "Negotiable  Instruments  Law  Annotated." 


12  1<  (REIGN  EXCHANGE 


$275.00  Boston,  Mass.,  June  15,  1916. 

Sixty  days  after  sight,  pay  to  the  order  of  John  Doe 
Two  Hundred  and  Seventy-Five  Dollars.  Value  received 
and  charge  to  my  account. 

To  C.  D.  Buyer,  A.  B.  Seller. 

45  Nassau  St., 
New  York. 


Trade  Bill 

The  three  parties  to  this  instrument  are: 

A.  B.   Seller   the  "drawer." 

C.  D.  Buyer the  "drawee." 

John  Doe   the  "payee." 

tional  order  in  writing  addressed  by  one  person  to  another, 
signed  by  the  person  giving  it,  requiring  the  person  to 
whom  it  is  addressed  to  pay  on  demand  or  at  a  fixed  or  de- 
terminable future  time  a  sum  certain  in  money  to  order 
or  to  bearer."  This  definition  states  briefly  the  require- 
ments to  which  an  instrument  must  conform  if  it  is  to  be 
a  negotiable  bill.  An  order  to  pay  money  which  fails 
to  meet  all  these  requirements  cannot  strictly  be  called  a 
bill  of  exchange,  but  it  would  be  an  error  to  suppose  that 
any  precise  formula  of  words  is  necessary  to  constitute  a 
legally  valid  bill.  In  the  specimen  given  above,  omission 
of  the  last  clause,  "value  received  and  charge  to  my  ac- 
count," would  have  no  effect  on  the  instrument,  at  least 
where  the  Uniform  Law  prevails.  The  various  printers' 
and  engravers'  embellishments  on  the  common  prepared 
blanks  for  checks,  drafts,  and  other  forms  of  bills,  are  with- 
out direct  legal  significance  except  for  the  words  which 
they  comprise. 

With  the  warning  that  the  trade  bill  is  but  one  of  several 


MEANS  OF  PAYMENT  AND  COMMERCIAL  PAPER   13 

types  of  bills  of  exchange,  let  us  now  explain  the  relations 
which  exist  in  regular  practice  among  the  three  parties  to 
this  instrument.  The  drawer,  or  one  who  writes  the  order, 
gives  directions  to  the  drawee  to  make  a  specified  payment 
of  money.  He  relies  upon  the  drawee's  following  out  his 
instructions  because  the  latter  owes  him  at  least  as  much 
money  as  he  has  ordered  paid  in  the  bill.  For  in  this 
instance  the  drawer  is  the  seller  of  goods  and  the  drawee 
is  the  one  who  has  bought  them  without  as  yet  having 
made  payment.  That  is,  the  drawer  is  a  mercantile  creditor 
and  the  drawee  is  his  debtor  in  the  case.  Concerning  the 
conditions  under  which  the  drawee  is  legally  bound  to  honor 
a  bill  we  shall  speak  in  the  next  section.  The  payee  is 
the  person  (individual,  firm,  corporation,  or  bank)  to  whom 
the  payment  is  ordered  made.  This  person  may  be  the 
original  payee  named  in  the  bill,  or  may  be  some  party  to 
whom  the  original  payee  has  transferred  the  instrument. 
When  the  drawee  makes  payment  on  the  bill,  to  the  payee, 
he  cancels  his  debt  to  the  drawer,  to  the  extent  of  the  sum 
so  paid.  He  discharges  his  debt  not  by  payment  direct  to 
his  original  creditor,  but  by  payment  to  a  third  party 
under  the  original  creditor's  orders. 

Mr.  Seller  is  the  drawer  of  the  specimen  bill  shown  above. 
The  payee  is  John  Doe.  The  clause  "pay  to  the  order  of 
John  Doe"  has  the  same  significance  as  "pay  to  John  Doe 
or  order,"  a  form  almost  equally  common,  and  means  pay 
to  John  Doe  or  to  any  one  to  whom  he  in  turn  directs 
payment  to  be  made.  Now  John  Doe  might  be  a  banker  or 
money  broker  or  he  might  be  an  individual  creditor  of  Mr. 
Seller's.  In  any  case  if  Seller  gives  Doe  a  bill  which  is 
payable  some  time  in  the  future,  it  will  be  customary  for 
Doe  to  receive  the  instrument  as  the  equivalent  of  a  sum 
of  present  cash  somewhat  less  than  the  full  amount  due  on 
it  at  its  maturity.  Thus  on  June  15  he  might  take  the  bill 
of  our  illustration,  which  presumably  will  yield  $275  on 


14  FOREIGN  EXCHANGE 

the  date  of  its  maturity,  as  being  the  equivalent  of  say 
$272.25  of  present  cash.  This  subject,  namely,  the  subject 
of  the  reduced  present  value  of  sums  due  in  the  future, 
will  be  taken  up  in  chapter  ii. 

While,  as  said,  this  John  Doe  might  be  an  individual 
creditor  of  Seller,  it  is  much  more  common  for  him  to  be 
a  banker,  who  is  either  buying  the  bill  or  taking  it  "for 
collection. ' '  Of  these  things  we  shall  speak  in  detail  later. 
In  either  event  the  bill  is  created  as  an  instrumentality 
whereby  the  mercantile  creditor  procures  payment  for  goods 
from  a  distant  debtor,  and  the  bank  intervenes  as  a  concern 
whose  business  it  is  to  aid  in  the  process  of  settlement.  If 
Seller  intended  to  dispose  of  the  bill  to  the  First  National 
Bank,  he  might  write  in  the  name  of  this  institution  as  the 
original  payee,  or  he  might  make  himself  the  first  payee,  by 
writing  for  instance  ' '  pay  to  the  order  of  myself, ' '  and  then 
transfer  to  the  bank  and  make  it  payee  by  indorsement.13 
A  bill  to  the  order  of  "mj-self"  or  "ourselves"  is  not  un- 
common. It  is  a  convenient  form  if  at  the  time  when  the 
instrument  is  drawn  it  is  not  certain  to  whom  it  will  be 
sold  or  transferred.  Concerning  what  happens  if  a  bill 
does  not  turn  out  good,  that  is,  if  the  drawee  fails  to  pay, 
we  shall  speak  in  §  12  below. 

For  a  long  period  the  trade  bill  has  occupied  a  position 
of  the  greatest  importance  in  the  foreign  commerce  of 
all  countries,  including  the  United  States.  It  has  played 
a  very  important  role  also  in  the  domestic  commerce  of  a 
number  of  countries.  But  up  to  the  present  day  it  has 
seen  little  service  in  the  domestic  trade  of  the  United 
States.  There  is  now  a  movement  in  progress  to  introduce 
it  here,  but  there  is  also  opposition. 

It  should  not  be  inferred  that  the  trade  bill,  that  is  to 
say,  the  bill  of  merchant  on  merchant,  has  been  hitherto 

is  Compare  §  1 1  below. 


MEANS  OF  PAYMENT  AND  COMMERCIAL  PAPER     15 

wholly  unknown  in  the  internal  trade  of  the  United  States. 
It  has  been  in  use,  usually  in  the  form  of  the  sight  bill, 
or  very  short  terni  bill,  with  documents  attached,14  but  it 
has  held  a  position  of  little  consequence.     Of  course  such 
forms  of  bills  of  exchange  as  checks  and  bankers'  sight 
drafts  have  had  a  tremendous  vogue  in  American  internal 
trade,15  while  in  our  foreign  trade  the  long  bill  on  the 
American  bank  is  now  becoming  of  the  greatest  importance. 
§  6.  The  acceptance. — The  drawee  is  not  legally  bound  to 
the  holder,  or  payee,  of  a  bill  unless  he  has  himself  taken 
action  to  make  the  bill  his  own  obligation.     The  mere  writ- 
ing and  signature  of  the  distinct  person,  the  drawer,  does 
not  make  the  bill  binding  upon  the  drawee,  and  this  is  true 
even  if  the  latter  owes  the  drawer  the  sum  of  money  called 
for  in  the  instrument.     This  proposition  may  be  summarized 
for  those  familiar  with  the  law  of  contracts  by  saying  that 
the  drawing  and  transfer  of  a  bill  of  exchange  does  not 
operate  as  an  assignment.     The  formal  act  whereby  the 
drawee  adopts  the  bill  as  his  own  obligation  is  known  as 
acceptance.     Acceptance  is,  as  the  Uniform  Law  states,  the 
written  signification  by  the  drawee   of  his  assent  to  the 
order  of  the  drawer.     This  is  accomplished  in  the  regular 
manner  by  writing  the  word  "accepted,"  with  the  date 
and  the  signature  of  the  drawee,  across  the  face  of  the  bill, 
usually  somewhat  oblicpiely  on  the  left  end  of  the  instru- 
ment.    If  the  bill  already  shown  is  accepted,  it  will  appear 
as  beneath. 

I*  Concerning  the  attachment  of  documents,  see  chapter  VI. 

is  A  curious  and  exceptional  use  of  the  bill  of  exchange  in  small 
domestic  business  is  as  a  means  of  forcing  a  slow  debtor  upon  whom 
the  creditor  would  never  think  of  drawing  a  draft  in  the  ordinary 
course  of  things.  A  debtor  who  persistently  refuses  payment  of  an 
overdue  account  is  drawn  upon  for  the  simple  purpose  of  forcing 
him  either  to  pay  or  to  disclose  his  refusal  to  some  local  bank  to 
which  the  draft  has  been  given  for  collection. 


16  FOREIGN  EXCHANGE 

$275.00  (  Boston,  Mass,  Jane  15,  1916. 

iy  to  the  order  of  John  Doe 


Two  Handred  and  Sgferi^ycf ive  Dollars.    Value  received  and 
charge  to  my  ace 


To  C  D.  Bayer, 

45  Hassau  St., 

New  York. 


iMA^^ 


Under  English  law  the  acceptance  must  be  written  upon 
the  bill  itself,  but  under  the  Uniform  American  Law  it  may 
be  written  on  a  separate  paper  and  bind  the  acceptor  to 
any  person  to  whom  this  paper  has  been  shown  and  who 
receives  the  bill  for  value  on  the  faith  of  this  separate 
acceptance.16  But  under  the  American  law  the  holder  has 
a  right  to  demand  an  acceptance  written  on  the  bill  itself, 
and  this  is  the  safe  and  regular  acceptance  practically  al- 
ways taken.  That  the  holder  has  a  "right"  to  demand  an 
acceptance  written  on  the  bill  signifies  that  if  this  kind  of 
an  acceptance  is  refused  by  the  drawee  the  holder  may  treat 
the  bill  as  dishonored  and  exercise  an  immediate  right  of 
recourse  on  the  drawer  or  any  indorser.  In  §  12  there 
will  be  found  an  explanation  of  the  nature  of  the  right  of 
recourse. 

The  word  "acceptance"  is  used  to  designate  (1)  the  act 
of  the  drawee  in  assuming  obligation  on  the  bill,  (2)  the 
written  words  added  to  the  bill,  and  (3)  the  bill  itself  after 
,  acceptance.  An  accepted  bill  is  more  commonly  called  an 
"acceptance"  than  anything  else.  If  Brown  draws  on 
Smith  and  Smith  accepts,  Smith  is  known  as  an  "  acceptor, ' ' 
and  thereafter  the  bill  is  known  as  Smith's  acceptance. 

16  See  Uniform  Law  §§221-2  (as  already  cited)  and  §  17  of  the 
English  Bills  of  Exchange  Act  (to  be  found  in  Huffcut  as  already 
cited ) . 


MEANS  OF  PAYMENT  AND  COMMERCIAL  PAPER  17 

It  is  evident  that  in  general  there  is  no  occasion  for  the 
acceptance  of  bills  payable  "at  sig-ht"  or  "on  demand." 
For  if  the  drawee  decides  to  treat  a  demand  bill  as  his  obli- 
gation it  is  his  duty  to  pay  it  forthwith.  He  takes  imme- 
diate possession  of  it  and  there  is  no  point  in  writing 
"accepted"  upon  it.17  In  the  case  of  long  or  time  bills,  it 
is  sometimes  essential  to  procure  acceptance  and  it  is  al- 
wajrs  advisable  and  in  order.  With  respect  to  the  bill 
drawn  payable  a  designated  period  after  sight,  or  after 
demand,  presentment  for  acceptance  is  necessary  in  order 
to  fix  the  date  of  maturity  of  the  instrument.  The  date  of 
the  acceptance  becomes  the  date  of  sight,  or  demand,  from 
which  the  due  date  is  fixed.  Further  explanations  respect- 
ing the  question  when  presentment  for  acceptance  is  essen- 
tial and  when  not,  are  best  postponed  to  §  12. 

§  7.  The  note. — A  bill  is  the  order,  but  a  note  is  the 
promise,  of  the  one  who  writes  it.  The  following  is  an 
example  of  a  note. 


$500.00  New  York,  N.  Y.,  June  15,  1919. 

Sixty  days  after  date,  for  value  received,  I  promise  to 
pay  to  the  order  of  Charles  D.  Brown,  Five  Hundred 
Dollars. 

Edward  F.  Jones. 


To  this  there  may  or  may  not  be  added  a  clause  promising 
interest,  such  as  the  clause  "with  interest  at  5%  per 
annum."  In  the  absence  of  the  clause,  the  full  sum  due 
upon  the  note  at  its  maturity  is  $500. 

17  The  certification  of  checks  by  the  drawee  banks  is  an  exception 
to  this  statement.  A  bank's  certification  of  a  check  is  an  acceptance 
of  a  demand  draft — which  it  is  the  design  of  the  drawer  or  other 
holder  to  send  in  payment  to  some  person  who  perhaps  insists  upon 
this  special   security. 


18  FOREIGN  EXCHANGE 

Brown  is  the  "payee"  and  Jones  the  "maker"  of  this 
instrument.  The  best  usage  does  not  permit  an  interchange 
of  the  names  of  the  parties  signatory  to  the  two  kinds  of 
negotiable  paper.  The  writer  of  the  promise  is  the 
"maker"  and  not  the  "drawer"  of  the  note.  The  writer 
of  the  order  is  the  "drawer"  and  not  the  "maker"  of 
the  bill.  The  definition  of  a  note,  as  given  in  the  Uniform 
Law,  is  "an  unconditional  promise  in  writing  made  by 
one  person  to  another  signed  by  the  maker  engaging  to  pay 
on  demand  or  at  a  fixed  or  determinable  future  time,  a 
sum  certain  in  money  to  order  or  to  bearer. ' ' 18  Promises 
in  writing  to  pay  money  might  be  so  worded  as  to  fail  to 
meet  some  of  the  requirements  of  this  definition  and  still 
be  called  notes  in  common  speech,  but  such  instruments 
would  not  be  negotiable  in  the  true  legal  sense  19  and  could 
not  be  called  promissory  notes  in  the  strict  meaning  of 
the  law.  In  fact,  however,  practically  all  notes  of  actual 
business  life  are  so  framed  as  to  conform  to  this  definition. 
They  are,  as  the  saying  goes,  made  "negotiable  in  form." 
No  precise  order  or  formula  of  words  is  prescribed  by  law 
for  the  note,  but  the  writing  such  as  it  is  must  have  a 
meaning  conformable  to  the  foregoing  definition,  if  the  in- 
strument is  to  be  a  note  in  the  strict  sense. 

The  two  principal  sources  of  the  ordinary  short-term 
notes  of  commerce  are  (1)  straight  loans  and  (2)  sales  of 
goods  on  time.  By  a  straight  loan  we  here  mean  a  direct 
advance  of  money,  or  of  a  right  to  draw  money,  to  a  person 
against  the  latter 's  own  promise  to  return  the  sum  in  the 
future  (with  something  added  for  interest,  of  course). 
The  straight  or  strict  loan  is  distinguished  from  an  advance 
made  to  a  person  by  purchasing  from  him  a  piece  of  com- 
mercial paper  made  payable  to  him  by  some  other  person; 

is  Uniform  Negotiable  Instruments  Law,  §320  (as  in  the  N.  Y. 
draft). 

i»  Compare  §  9. 


MEANS  OF  PAYMENT  AND  COMMERCIAL  PAPER   19 

or  from  an  advance  in  any  other  form  which  amounts  to 
a  virtual  though  not  a  direct  loan.  The  great  volume  of 
short-term  straight  loans  in  a  country  are  of  course  made 
by  the  banks  to  their  clients  in  all  lines  of  business.  Pre- 
sumably a  note  is  given  the  bank  for  every  loan  of  this  type. 
If  the  loan  is  "  on  call  "  or  on  demand,  a  demand  or  sight 
note — which  is  simply  one  payable  at  any  time  when  demand 
for  payment  is  made — or  a  one-day  note,  will  be  given. 
In  the  ease  of  the  eall  loan  in  New  York,  the  borrower 
is  entitled  to  notice  on  the  day  preceding  the  demand.  If 
the  loan  is  for  a  specified  period,  the  note  will  usually  be 
made  to  fall  due  at  the  end  of  that  period,  though  it  might 
be  understood  that  a  loan  is  to  run  for  a  longer  time  than 
the  first  note.  This  implies  a  right  or  privilege  of  paying 
off  the  first  note  by  making  a  second.  Sometimes  loans 
which  are  to  run  for  a  considerable  though  indeterminate 
period  will  be  evidenced  by  demand  notes.  The  makers 
of  notes  often  effect  their  loans  by  disposing  of  them  either 
to  a  broker  or  through  a  broker. 

As  indicated,  sales  of  goods  on  time  are  a  second  impor- 
tant source  of  short-term  notes.  Such  sales  also  give  rise 
to  long  bills  of  exchange,  where  the  buyer  of  the  goods 
is  at  a  distance  and  where  bills  are  in  vogue.  Also  myriads 
of  such  transactions  result  only  in  a  "book  account"  or 
charge  against  the  purchaser  of  the  merchandise  upon  the 
books  of  the  seller.  But  sometimes  the  buyer  may  give  the 
seller  his  note.  The  specimen  note  given  at  the  beginning 
of  this  section  might  have  arisen  out  of  a  sale  of  $500 
worth  of  goods  by  Brown  to  Jones  on  60  days'  time.  The 
chief  advantage  to  Brown  of  the  note,  as  distinguished  from 
a  mere  book  account  against  Jones,  is  its  superior  avail- 
ability in  Brown's  hands  as  a  means  of  obtaining  present 
cash.  Brown  may  sell  the  note  for  perhaps  $495.  Or  he 
may  pledge  it  as  collateral  security  for  a  direct  loan  against 
his  own  note.     For  either  of  these  uses  a  note  is  indefinitely 


20  FOREIGN  EXCHANGE 

more  acceptable  under  our  law  and  custom  than  a  document 
assigning  (i.e.,  transferring)  the  claim  witnessed  by  a  mere 
book  account. 

§  8.  Checks,  drafts,  and  exchange. — Though  the  check  is 
the  most  familiar  of  all  forms  of  credit  instruments,  we 
give  an  example  for  the  sake  of  completeness. 


No.  223  New  York,  June  15,  1913. 

The  Fiftieth  National  Bank  of  New  York 

Pay  to  the  order  of  Charles  D.  Brown $275.00 

Two  Hundred  and  Seventy-five ~  Dollars. 

Edward  F.  Jones. 


A  check  is  to  be  denned  as  (1)  a  bill  of  exchange  (2)  drawn 
on  a  bank  (3)  payable  on  demand.  That  is,  a  check  as  a 
legal  instrument  is  a  particular  sub-class  under  bill  of 
exchange.20  The  ordinary  form  of  domestic  bank  check 
specifies  no  time  of  payment.  Any  negotiable  instrument 
which  expresses  no  time  of  payment,  is  payable  on  demand. 
Checks  are  subject  to  the  rules  which  govern  bills  in  general, 
but  there  are  certain  subsidiary  laws  which  apply  to  checks 
alone. 

The  terms  "promissory  note,"  "bill  of  exchange,"  and 
"check"  stand  for  definite  legal  concepts,  and  are  given 
formal  definitions  in  statutory  law.  But  the  term  "draft" 
has  neither  a  fixed  legal  nor  commercial  significance,  beyond 
the  fact  that  it  always  refers  to  an  instrument  that  is  drawn 
upon  a  drawee  and  therefore  partakes  of  the  nature  of  a 
bill  of  exchange.  There  are  eases  where  instruments  which 
do  not  conform  to  the  legal  requirements  of  a  bill  of  ex- 

20  Compare  the  Uniform  Negotiable  Instruments  Law,  as  already 
cited,   §321. 


MEANS  OF  PAYMENT  AND  COMMERCIAL  PAPER      21 

change  and  which  have  therefore  been  denied  the  name  bill, 
are  still  spoken  of  as  drafts  by  the  courts.  The  best  we 
can  say  of  the  word  is  that  it  is  a  loose  synonym  for  bill 
of  exchange,  but  that  when  it  is  used  in  a  distinctive  sense 
it  usually  means  a  bill  drawn  on  a  bank,  whether  at  sight 
or  for  a  term,  whether  drawn  by  another  bank  or  by  a 
merchant,  and  excludes  the  bill  drawn  by  merchant  on 
merchant.  A  Chicago  bank's  sight  bill  on  its  New  York 
correspondent  would  virtually  always  be  called  a  New  York 
draft.21 

As  a  term  for  commercial  paper  the  word  "exchange" 
is  commonly  used  to  designate  bills,  drafts,  or  checks  drawn 
in  one  place  upon  another  place.  A  promissory  note  held 
by  a  payee  in  one  place  but  payable  by  a  maker  in  another 
place,  might  possibly  be  called  exchange,  but  the  word  is 
not  usually  thought  of  as  covering  such  instruments.  Ex- 
change takes  its  geographical  name  from  the  place  upon 
which  it  is  drawn,  or  where  it  is  payable.  Thus  Chicago, 
New  York,  or  Paris  exchange,  consists  respectively  in  bills 
drawn  on  persons,  firms,  corporations,  or  banks,  in  these 
places,  regardless  of  the  place  of  origin  of  the  drafts. 
Local  checks,  because  they  are  local,  that  is,  drawn  on  a 
bank  in  the  same  place  as  the  drawer  himself,  are  never 
called  exchange,  unless  they  chance  to  migrate  to  a  distant 
place  and  thus  in  effect  cease  to  be  "local." 

^i  In  "Smith's  Financial  Dictionary"  (New  York,  1908),  it  is  stated 
"there  is  practically  no  difference  between  a  liill  of  exchange  and  a 
draft.  The  term  liill  of  exchange,  however,  is  commonly  applied  to 
an  order  for  money  payable  in  a  foreign  country,  whereas  the  term 
draft  is  applied  to  an  order  payable  within  the  country  of  its 
origin."  This  hardly  seems  to  describe  such  usage  as  there  is.  The 
bills  of  American  banks  on  their  English  correspondents  are  often 
called  "sterling  drafts,"  and  bills  drawn  by  merchants  on  foreign 
banks  under  letters  of  credit  are  also  called  drafts. 


CHAPTER  II 
THE  NEGOTIABILITY  OF  COMMERCIAL  PAPER 

§  9.  Negotiability. — Bills  and  notes  are  called  "negotiable 
instruments"  and  possess,  as  we  say,  the  legal  attribute  of 
negotiability.  We  have  here  a  subject  which  is  capable 
of  comprehensive  explanation  only  in  a  technical  legal 
treatise.  It  is  highly  desirable  nevertheless  for  the  student 
of  exchange  to  gain  some  idea  of  the  meaning  and  effect 
of  the  negotiability  of  commercial  paper.  We  venture  to 
discuss  the  more  general  aspects  of  the  subject  in  the  present 
chapter.  Passing  over  certain  inexact  commercial  uses,  or 
misuses,  of  "negotiable"  as  a  mere  synonym  for  transfer- 
able or  again  for  readily  saleable,  we  find  two  meanings 
commonly  attaching  to  the  term  at  law,  one  lax  and  the 
other  strict.  The  lax  meaning  is — transferable  by  indorse- 
ment and  delivery  so  as  to  give  the  transferee  (or  one  to 
whom  transfer  is  made)  a  right  of  action  in  his  own  name. 
In  this  sense  the  term  may  be  predicated  of  various  types 
of  documents,  receipts,  and  warrants  calling  for  the  de- 
livery of  money  or  of  goods,  but  cannot  of  course  be  predi- 
cated of  actual  goods,  which  are  unsuitable  for  indorsement. 
In  its  strict  meaning  the  term  includes  all  this  and  also 
an  additional  element  of  peculiar  interest  and  importance. 
The  tremendous  circulation  attained  by  commercial  paper 
may  be  said  to  be  founded  upon  its  peculiar  and  strict 
negotiability. 

To  proceed  with  an  explicit  statement,  negotiability  in 
the  strict  sense,  namely,  the  legal  character  peculiar  to 
what  is  known  as  commercial  paper,  means  the  legal  attri- 
bute of  transferability  under  laws  which  make  it  possible, 
first,  that  the  transferee  may  sue  in  his  own  name ;  second, 
that  the  rights  of  the  transferee  may  under  some  circum- 

22 


THE  NEGOTIABILITY  OF  COMMERCIAL  PAPER      23 

stances  become  superior  to  the  rights  which  the  transferor 
had  to  convey.  Stated  in  another  way  the  second  point 
means  that  the  one  who  receives  a  note  or  bill  may  in  man}' 
cases  be  able  to  collect  on  it  when  the  one  who  transferred 
or  sold  it  to  him  could  not  collect  or  enforce  payment. 
Or  again,  the  party  obligated  on  the  instrument  may  have 
certain  defenses  which  would  be  good  against  the  transferor 
while  the  transferee  might  be  exempt  from  them. 

Returning  to  the  first  mentioned  and  less  essential  feature 
of  negotiability,  in  present  law  most  ordinary  contract 
rights,  for  the  use  or  receipt  of  property  or  the  receipt 
of  money,  may  be  transferred  by  the  party  who  has  them 
to  a  third  party,  so  that  the  latter  may  exercise  these  rights, 
but  no  more  than  these,  against  the  person  bound  by  the 
contract.  In  this  case  the  transferee  is  merely  substituted 
in  the  place  of  the  transferor,  as  far  as  the  latter 's  rights 
are  concerned.  The  transfer  of  contract  rights  is  speci- 
fically known  as  assignment,  and  the  transferee  as  an  as- 
signee. In  the  absence  of  statutory  provisions  to  the  con- 
trary, an  assignee  can  sue  the  obligor  only  in  the  name  of 
the  assignor.  The  power  of  the  transferee  of  a  negotiable 
instrument  to  sue  upon  it  in  his  own  name  is  then  one 
point  of  contrast  between  negotiability  and  assignability. 
This  point  is  of  less  importance  than  the  second  mentioned 
feature  of  negotiability  because  it  concerns  only  a  matter 
of  procedure  rather  than  the  substantive  rights  of  the 
holder,  and  also  because  statutes  are  common  to-day  which 
give  assignees  the  power  to  sue  in  their  own  names. 

With  regard  to  the  second  feature  of  negotiability,  it 
may  be  stated  as  a  general  rule  of  law  that  a  person  who 
has  a  right,  title,  claim,  or  interest,  cannot  give  to  his 
transferee  any  better  right  or  title  than  he  himself  has. 
That  which  he  does  not  himself  hold  he  cannot  transfer. 
Thus  if  A,  while  appearing  to  hold  a  good  title  to  a  piece 
of  land  or  a  horse,  really  has  no  title,  or  has  a  title  subject 


24  FOREIGN  EXCHANGE 

to  liens  or  liabilities,  or  to  defeat,  B  to  whom  he  sells  will 
in  general  obtain  either  no  title  or  a  title  suffering  from 
the  same  defects,  as  the  case  may  be.  Again,  if  A  has  a 
contract  right  to  receive  money  from  C,  and  C  can  for  any 
reason,  such  as  counterclaim,  lack  of  consideration,  or 
fraud,  defend  himself  against  payment  to  A,  he  can  use 
precisely  the  same  defenses  against  B,  the  assignee  of  A. 
It  is  a  general  though  not  universal  rule  of  law  that  a 
transferor  can  confer  upon  his  transferee  no  better  rights 
than  he  himself  has.  The  chief,  though  not  only,  articles 
of  ownership  and  agreement  which  are  exceptions  to  this 
rule  are  negotiable  instruments  and  money.  This  brings 
us  to  the  subject  of  the  defenses  against  payment  of  nego- 
tiable instruments. 

§  10.  The  defenses  against  payment  of  negotiable  instru- 
ments.— The  defenses  which  an  obligor  or  ostensible  obligor 
upon  a  negotiable  instrument  may  set  up  against  its  holder 
fall  into  two  classes:  (1)  Real  or  absolute  defenses,  or  those 
good  against  any  holder  whatsoever  or  good  against  all  the 
world;  (2)  personal  defenses,  or  those  good  against  some 
persons  but  not  against  a  person  known  as  the  "holder  in 
due  course."  The  latter  is  a  person  who  has  purchased, 
or  given  value  for,  the  instrument  before  its  maturity,  and 
who  is  without  notice  of  any  infirmity  in  it  or  defect  in 
the  title  to  it  of  a  party  who  has  held  it  prior  to  himself. 
He  is  often  called  the  "innocent  purchaser  for  value." 
It  is  rare  in  actual  business  life  for  a  person  or  company 
that  holds  a  note  not  to  be  an  example  of  a  holder  in  due 
course.  A  person  who  derives  his  title  through  a  holder 
in  due  course  without  himself  being  able  to  qualify  as 
such,  will,  if  he  is  not  himself  a  party  to  some  fraud  or 
illegality  affecting  the  instrument,  enjoy  the  same  exemp- 
tion from  personal  defenses.1 

i  On  the  holder  in  due  course,  see  "Uniform  Negotiable  Instru- 
ments Law"   (as  already  cited),  Article  V. 


THE  NEGOTIABILITY  OF  COMMERCIAL  PAPER      25 

The  chief  of  the  obligor's  absolute  defenses  are:  (1) 
That  the  instrument  is  a  forgery;  (2)  that  he,  the  obligor, 
is  a  person  without  legal  capacity  to  make  contracts ;  or 
(3)  that  the  instrument  originated  in  circumstances  which 
make  it  totally  void  under  a  special  statute,  such  as  a 
Pennsylvania  statute  which  make  notes  given  on  account 
of  a  gambling  debt  utterly  void.  The  leading  personal 
defenses  are:  (1)  Lack  or  failure  of  consideration;  (2)  set- 
off or  counterclaim;  (3)  fraud;  and  (4)  duress.  Suppose 
that  A  has  made  and  handed  over  his  note  to  B  for  a  horse 
which  it  is  agreed  B  will  deliver  to  A,  but  that  thereafter 
B  in  fact  fails  to  surrender  the  animal.  Then  B  could 
not  collect  on  the  note  because  of  A's  defense  of  "failure 
of  consideration."  But  the  defense  is  personal.  For  if 
B  should  indorse  the  note  to  C,  C  being  without  knowledge 
of  the  defects  in  B's  rights  and  being  in  other  respects 
also  a  holder  in  due  course,  C  can  collect  from  A.  C  is 
exempt  from  this  personal  defense.  To  make  a  long  story 
short,  the  immunity  of  the  innocent  purchaser  for  value 
from  a  number  of  defenses  which  might  be  good  against 
parties  prior  to  him  is  the  essential  feature  of  negotiability. 
If,  in  the  instance  of  the  foregoing  illustration,  B,  who 
promised  to  deliver  the  horse  and  failed,  had  held  merely 
some  ordinary  or  non-negotiable  contract  claim  for  money 
against  A,  and  C  became  his  assignee,  C  could  no  more 
collect  than  B,  no  matter  how  "innocent"  he  might  be  nor 
what  consideration  he  had  given  B. 

As  has  already  been  intimated,  money  is  like  the  negotia- 
ble instrument  in  that  a  person  without  title  to  it  or  wrong- 
fully in  possession  of  it  may  transfer  it  to  another,  who 
takes  it  innocently  and  for  a  consideration,  with  the  effect 
of  giving  this  other  perfect  rights,  both  as  against  the 
original  owner  and  as  against  all  the  world.  Suppose  B 
steals  a  $20  gold  piece  from  A  and  spends  it  in  C's  store. 
If  C  is  without  knowledge  of  the  theft  A  cannot  take  the 


26  FOREIGN  EXCHANGE 

coin  away  from  him  when  the  facts  are  found  out  or  proved. 
Money  is  doubtless  the  original  essentially  negotiable  article 
in  the  world.  The  only  other  class  of  things  that  usually 
possess  strict  and  full  negotiability  are  the  particular  forms 
of  contracts  for  money  known  as  bills  and  notes.  In  their 
negotiability  these  contracts  are  made  like  the  money  in 
which  they  are  dischargeable.  Documents  such  as  bills  of 
lading  and  warehouse  receipts,  which  call  for  the  delivery 
of  goods,  may,  however,  be  given,  by  statute,  some,  or  all 
of  the  characters  of  strict  negotiability.  In  the  first  case 
they  are  properly  known  as  quasi-negotiable. 

The  negotiability  of  commercial  paper  is  of  the  greatest 
importance  to  the  freedom  of  its  circulation.  "When  a 
banker  or  a  broker  buys  an  acceptance  from  some  person, 
and  thus  becomes  one  in  the  series  of  its  holders,  he  is  not 
forced  to  inquire  whether  a  consideration  was  given  by 
every  prior  holder  to  obtain  the  instrument,  or  whether 
any  counterclaim  against  a  prior  party,  or  fraud  concealed 
somewhere  in  the  history  of  the  instrument,  invalidates  his 
rights.  "Were  the  instrument  a  mere  assignable  contract 
for  money,  he  would  be  compelled  to  have  a  care  regarding 
these  matters.  If  checks,  bills,  and  notes  were  merely 
assignable,  it  would  seem  out  of  the  question  for  them  to 
obtain  the  enormous  significance  which  they  now  possess 
as  substitutes  for  money  in  the  traffic  of  the  world. 

§  11.  Negotiation. — The  act  of  transferring  title  or  owner- 
ship in  a  negotiable  instrument  is  known  as  negotiation. 
If  an  instrument  is,  as  it  stands,  payable  to  a  specified 
person,  negotiation  can  be  accomplished  only  by  indorse- 
ment and  delivery.  If  it  is  payable  to  bearer,  delivery 
alone  will  suffice.  Indorsement  consists  in  the  payee's 
writing  his  signature  (with  or  without  additional  words 
conveying  instructions  or  qualifying  liability)  upon  the 
bill  or  note,  or  sometimes  upon  the  "allonge."  The  latter 
is  a  sticker   (rarely  needed)   which  is  attached,  properly 


THE  NEGOTIABILITY  OF  COMMERCIAL  PAPER      27 

upon  the  back  of  the  instrument,  to  take  additional  signa- 
tures when  there  is  insufficient  space  for  them  remaining 
on  the  back  of  the  bill  or  note  itself.  The  regular  place 
for  an  indorsement  is  upon  the  back  of  the  instrument, 
and  to  follow  good  usage  the  first  indorser  should  write 
his  signature  across  the  reverse  of  the  left-hand  end,  other 
indorsers  being  expected  to  place  theirs  beneath  this  and 
in  the  order  of  time  in  which  they  indorse.  However,  the 
stamped  indorsements  which  are  very  common  to-day  are 
put  on  without  much  regard  for  the  rule,  except  that  they 
are  always  impressed  on  the  back  of  the  instrument. 

As  classified  in  the  Uniform  Law,  indorsements  are  (1) 
special,  (2)  blank,  (3)  restrictive,  (4)  qualified,  and  (5) 
conditional.  A  special  indorsement  is  one  which  specifies 
the  person  to  whom,  or  to  whose  order,  the  instrument  is 
to  be  payable.     Thus: 


Pay  to  the  order  of 
John  Doe. 

Richard  Roe. 


Here  the  indorsement  of  John  Doe  will  be  necessary  for 
further  negotiation.     Thus: 


(1) 


(2) 


Pay 

to  the  order  of 

John  Doe. 

Richard  Roe. 

Pay 

to  the  order  of 

Tom  Jones. 

John  Doe. 

28 


FOREIGN  EXCHANGE 


The  first  indorsement,  being  special,  makes  necessary  John 
Doe's  signature  for  any  farther  negotiation.  The  second 
indorsement  might  then  appear  as  above. 

A  blank  indors<  ment,  or  indorsement  in  blank,  is  one 
which,  specifies  no  payee.  If  we  were  to  change  the  second 
indorsement  above  into  one  in  blank,  the  back  of  the  bill 
or  note  would  appear  as  follows : 


(1) 


(2) 


Pay 

to  the 

order  of 

John  Doe. 

Richard  Roe. 

John 

Doe. 

Blank  indorsements  are  commonest  perhaps  when  the  payee 
negotiates  a  check  to  his  bank  for  the  credit  of  his  account. 
The  legal  effect  of  a  blank  indorsement  is  to  make  the 
instrument  paj^able  to  bearer  and  to  make  it  capable  of 
further  negotiation  by  delivery  only  and  without  additional 
indorsement.  The  bearer  or  holder  of  an  instrument  so 
indorsed  may  be  required,  however,  to  place  his  indorse- 
ment upon  it  at  the  time  of  making  a  further  negotiation. 
The  purpose  here  would  be  to  make  the  record  clear  and 
also  to  make  this  person  assume  the  indorser's  liability  on 
the  instrument.  A  bill  or  note  indorsed  which  is  in 
blank  may  easily  come  to  bear  a  subsequent  special  indorse- 
ment. 

Omitting  consideration  of  the  third  and  fifth  kinds  of 
indorsements,  into  whose  technicalities  we  had  better  not 
go,  it  remains  to  speak  of  the  qualified  indorsement.  This 
is  constituted  by  adding  to  the  indorser's  signature  the 
words  ''without  recourse"  or  words  of  similar  import. 
Thus: 


THE  NEGOTIABILITY  OF  COMMERCIAL  PAPER      20 


Pay  to  the  order  of 
John  Doe. 

Richard  Roe. 
Without  recourse. 


This  indorsement  releases  Roe  from  such  of  his  liabilities  as 
are  imposed  upon  him  by  law  as  a  part  of  the  "indorser's 
contract,"  but  leaves  him  with  certain  other  liabilities 
which  still  belong  with  him  as  a  "vendor"  or  seller  of  the 
instrument.  This  indorsement  has  itself  no  effect  upon 
the  liability  of  other  indorsers,  and  no  effect  upon  the 
negotiability  of  the  instrument.  This  brings  us  to  the  sub- 
ject of  the  liability  of  parties. 

§  12.  The  liability  of  parties. — The  parties  liable  to  make 
payment  on  negotiable  instruments  are  divisible  into  two 
main  classes.  The  first  class  consists  of  those  that  are, 
according  to  the  terms  of  the  instrument,  unconditionally 
bound  to  pay,  and  includes  the  maker  of  a  note  and  the 
acceptor  of  a  bill.  These  parties  are  frequently  spoken  of 
as  "principal  obligors,"  and  it  is  from  them  alone  that 
payment  is  expected  in  regular  course.  The  second  class 
contains  all  parties  who  are  liable  to  pay  only  on  condition 
that  the  principal  obligor  dishonors  the  instrument,  whether 
by  non-payment  in  the  case  of  a  note  or  bill,  or  by  non- 
acceptance  in  the  case  of  a  bill.  Any  one  of  these  parties 
is  in  the  position  of  representing  to  the  holder  that  the 
principal  obligor  will  honor  the  instrument.  He  further- 
more represents  that  if  the  principal  obligor  refuses  to 
honor  it,  then  he  himself  will  pay  it,  provided  the  holder 
has  made  a  suitable  attempt  to  procure  honor  by  the  prin- 
cipal obligor.  The  principal  obligor  is  by  his  own  acknowl- 
edgment unconditionally  bound  to  pay,  in  the  sense  that 
he  has  made  himself  obligor  on  an  unconditional  promise 


30  FOREIGN  EXCHANGE 

or  order  (compare  the  definitions  already  given  of  the 
note  and  the  bill).  This  does  not  mean  that  he  may  not 
avail  himself  of  the  defenses  against  payment  heretofore 
discussed,  when  these  defenses  exist,  bnt  means  that  apart 
from  such  defenses  his  liability  is  not  conditional  upon  the 
happening  of  any  event,  and  not  conditional  upon  the  fail- 
ure of  some  other  party  to  pay.  The  following  conspectus 
shows  the  parties  to  negotiable  instruments,  classified  ac- 
cording to  liability. 

In  this  tabulation  primarily  is  used  in  the  sense  of  uncon- 
ditionally, and  secondarily  in  the  sense  of  conditionally* 

Parties  Primarily  or  Unconditionally  Liable. — (Parties  ex- 
pected in  ordinary  course  to  pay  the  instrument.) 
The  maker  of  a  promissory  note. 
The  acceptor  of  a  bill  of  exchange. 

Parties  Secondarily  or  Conditionally  Liable. —  (Parties  not 
expected  in  ordinary  course  to  pay  the  instrument.) 
The  ordinary  indorser  of  either  a  note  or  a  bill. 
The  drawer  of  a  bill,  both  before  and  after  the  drawee's 
acceptance  of  the  instrument. 

Party  not  Having  Liability. — The  drawee  of  a  bill  prior  to  his 
acceptance  of  the  same. 

It  has  already  been  explained  that  the  drawee  of  a  bill 
has  no  liability  whatever  on  the  instrument  until  he  gives 
his  acceptance,  even  if  he  owes  the  drawer  money  and  even 
if  the  latter  has  ever  so  valid  a  commercial  expectation 
that  the  bill  will  be  honored.     This  applies  to  checks  drawn 

2  A  commonly  accepted  legal  classification  of  parties,  differing  in 
the  place  assigned  the  drawer  of  a  bill  prior  to  acceptance,  will  be 
discussed  in  the  note  at  the  end  of  the  present  section.  §  3  of  the 
Uniform  Law  states :  "The  person  'primarily'  liable  on  an  instru- 
ment is  the  person  who  by  the  terms  of  the  instrument  is  abso- 
lutely required  to  pay  the  same.  All  other  parties  are  'secondarily' 
liable." 


THE  NEGOTIABILITY  OF  COMMERCIAL  PAPER      31 

on  banks  unless  a  special  statute  runs  to  the  contrary.  That 
is,  the  payee  (other  than  the  drawer  himself)  of  a  check 
has  no  action  against  the  bank  if  it  refuses  to  pay,  even 
when  the  drawer  is  in  funds  with  the  bank.  "What  he  has 
is  recourse  on  the  drawer.  As  a  matter  of  convenience  we 
speak  of  the  drawee  as  a  party  even  prior  to  his  acceptance, 
though  before  this  act  he  is  not  a  real  contracting  party. 
If  we  are  to  speak  of  him  as  a  party  at  this  time  it  becomes 
incumbent  upon  us  to  point  out  that  he  has  for  the  time 
being  no  liability,  conditional  or  unconditional. 

With  the  warning  that  we  have  here  to  do  with  an  ex- 
tensive and  difficult  subject  and  that  this  book  attempts 
only  to  give  certain  more  general  explanations  which  ought 
to  be  understood  by  the  student  of  exchange,  let  us  con- 
sider the  liability  of  indorsers  of  bills  and  notes,  and  of 
drawers  of  bills.  When  the  present  holder  and  payee  of  a 
negotiable  instrument  indorses  it  and  negotiates  it  to  an- 
other person  he  becomes  (1)  an  indorser,  and  (2)  a  vendor 
(or  seller)  of  the  instrument  as  a  ''chattel."  In  each  of 
these  capacities  he  incurs  distinct  liabilities.  As  an  in- 
dorser he  is  under  a  liability  to  pay  the  full  face  value  of 
the  instrument  to  any  holder  subsequent  to  himself,  but 
this  liability  is  secondary  and  depends  upon  the  happening 
of  three  very  precise  events.  These  are  (1)  proper  present- 
ment, (2)  dishonor,  and  (3)  due  notice  of  dishonor. 

The  act  of  taking  a  negotiable  instrument  to  the  prin- 
cipal obligor  and  demanding  that  he  make  payment,  and 
the  act  of  taking  a  bill  of  exchange  to  the  drawee  and 
demanding  that  he  accept  it,  are  both  known  as  present- 
ment. The  first  is  presentment  for  payment  and  the  sec- 
ond presentment  for  acceptance.  The  promissory  note  can, 
of  course,  experience  but  one  kind,  that  is,  presentment  for 
payment.  With  respect  to  bills  of  exchange,  there  is,  as 
has  already  been  explained,  in  regular  course  no  occasion 
for  the  acceptance  of  sight  bills  as  a  formal  act  distinct  from 


32  FOREIGN  EXCHANGE 

payment.     Long   or    time   bills   fall   into   two   subclasses: 

(1)  Those  payable  a  stated  period  after  sight  or  demand; 

(2)  those  payable  a  stated  period  after  date.  (Bills  pay- 
able on  a  specified  future  date  would  belong  to  this  second 
subclass  if  it  were  customary  to  draw  them.)  In  the  case 
of  the  first  subclass,  presentment  for  acceptance  is  required. 
In  the  instance  of  the  second  subclass  it  is  not  required, 
with  two  exceptions,  namely  (a)  where  the  bill  expressly 
stipulates  that  it  shall  be  presented  for  acceptance,  and 
(b)  where  the  bill  is  drawn  payable  elsewhere  than  at  the 
place  of  business  or  residence  of  the  drawee.3 

When  we  speak  of  presentment  being  required,  we  mean 
that  it  is  required  in  order  to  prevent  the  parties  second- 
arily liable  from  escaping  their  liability ;  or,  otherwise  ex- 
pressed, in  order  "to  bind  the  parties  secondarily  liable." 
Presentment  for  acceptance  of  bills  payable  a  designated 
period  after  sight  is  necessary  for  this  purpose.  In  general 
it  is  not  necessary  in  the  case  of  any  other  class  of  bills. 
But  most  long  bills  are  in  fact  worded  as  payable  a  specified 
time  after  sight.  The  presentment  of  these  bills  is  also 
necessary  in  order  to  fix  the  date  ' '  of  sight ' '  and  from  it  the 
date  of  maturity. 

Speaking  broadly,  the  party  secondarily  liable  is  liable 
on  the  general  condition  that  payment  cannot  be  obtained 
from  the  principal  obligor.  But  speaking  more  specifically, 
he  is  liable  on  the  three  special  conditions,  provided  by  law, 
which  are,  (1)  presentment,  (2)  dishonor,  (3)  notice,  that 
is,  notification  of  dishonor.  The  object  of  the  rule  that  the 
holder  of  the  instrument  must  make  proper  presentment  or 
presentments  to  the  principal  obligor  is  to  prevent  the 
holder  from  having  recourse  upon  the  parties  secondarily 
liable  without  first  having  made  a  proper  effort  to  obtain 
payment  from  the  party  primarily  liable.     By  a  "proper" 

3  See  Uniform  Law,  §  240,  and  British  Bills  of  Exchange  Act,  §  39  = 


THE  NEGOTIABILITY  OF  COMMERCIAL  PAPER      33 

presentment  is  meant  specifically  one  which  is  made  at  the 
time,  the  place,  and  in  the  manner  prescribed  by  law  as 
necessary  to  make  the  presentment  serve  as  the  first  condi- 
tion for  charging  the  secondary  parties  with  their  liability. 
There  are  a  number  of  detailed  rules  governing  proper 
presentment.  To  illustrate  their  character,  suppose  a  note 
falls  due  on  the  business  day  of  Wednesday,  March  10. 
Presentment  for  payment  must  be  made  on  this  very  date, 
and  not  on  March  9,  or  March  11,  if  the  parties  secondarily 
liable  are  to  be  bound.  A  technically  improper  present- 
ment is  wholly  worthless  for  binding  these  parties.  On  the 
other  hand,  the  reader  will  of  course  understand  that  fail- 
ure to  make  proper  presentment  for  payment  does  not  in 
the  least  affect  the  liability  of  the  principal  obligor.  This 
liability  endures  until  the  statute  of  limitations  brings  it 
to  an  end. 

Proper  presentment  having  taken  place,  the  second  event 
which  must  occur  to  bind  the  parties  secondarily  liable  is 
dishonor.  Dishonor  is  either:  (1)  The  refusal  of  the  prin- 
cipal obligor  on  a  note  or  an  accepted  bill,  or  a  bill  due 
without  presentment  for  acceptance,  to  make  payment  when 
it  is  presented  for  payment;  or  (2)  the  refusal  of  a  drawee 
to  accept  a  bill.4  The  first  is  called  dishonor  for  non-pay- 
ment, and  the  second  dishonor  for  non-acceptance.  If  a 
bill  is  dishonored  for  non-acceptance  it  is  not  necessary  that 
it  should  also  be  dishonored  for  non-payment  in  order 
that  the  drawer  and  indorsers  should  be  bound.  Where 
presentment  for  acceptance  of  long  bills  is,  as  explained 
above,  not  required  of  the  holder,  he  may  make  such  a 

*  A  bill  or  note  may  be  technically  dishonored  for  non-payment 
where  it  is  overdue  and  unpaid  and  the  conditions  are  such  that  the 
law  excuses  presentment,  as  for  instance  "where  after  reasonable 
diligence  presentment  .  .  .  cannot  be  made"  (§  142  of  the  Uniform 
Law).  A  bill  also  becomes  dishonored  for  non-acceptance  where 
presentment  for  acceptance  is  excused  and  the  bill  is  not  accepted 
(§§  143  and  24G). 


34  FOREIGN  EXCHANGE 

presentment  voluntarily.  If  dishonor  is  then  experienced, 
this  (with  notification)  serves  to  charge  the  parties  second- 
arily liable. 

If  dishonor  has  taken  place,  the  third  condition  necessary 
to  bind  the  parties  secondarily  liable  is  that  due  notice  of 
dishonor  be  sent  them.  Among  the  numerous  rules  relative 
to  notice,  the  most  important  perhaps  are  that  it  must, 
except  under  special  circumstances,  be  given  or  started  by 
mail  within  one  business  day  after  the  dishonor  takes  place, 
and  that  no  party  secondarily  liable  is  charged  unless  notice 
be  given  him  or  his  agent.  Notice  of  dishonor  may  be  dis- 
pensed with  when  "after  the  exercise  of  reasonable  dili- 
gence, it  cannot  be  given  to  or  does  not  reach  the  parties 
sought  to  be  charged"  ("Uniform  Law"  §183).  And 
delay  in  giving  notice  is  excused  "when  the  delay  is  caused 
by  circumstances  beyond  the  control  of  the  holder  and  not 
imputable  to  his  default,  misconduct,  or  negligence. 
"When  the  cause  of  delay  ceases  to  operate,  notice  must  be 
given  with  reasonable  diligence  "  (§184).  Delay  in  making 
presentment  for  payment  is  also  excused  under  the  same 
rule. 

The  holder's  demand  upon  a  party  secondarily  liable,  for 
payment  of  an  instrument  dishonored  by  the  drawee  or  by 
the  principal  obligor,  is  called  recourse.  The  holder  may 
take  recourse  upon  any  one  of  the  parties  secondarily  liable. 
When  one  of  these  pays,  this  one  may  in  turn  take  recourse 
upon  the  party  from  whom  he  himself  received  the  instru- 
ment or  upon  any  other  party  secondarily  liable  prior  to 
himself.  Meanwhile  the  obligations  of  the  party  primarily 
liable  remains  (except  in  the  case  of  the  unaccepted  bill), 
and  the  last  party  secondarily  liable  to  pay  the  instrument 
has  this  to  fall  back  on,  for  whatever  it  is  worth,  this  being 
just  what  he  had  when  he  passed  the  instrument  on  for  a 
consideration.  Since  one  party  secondarily  liable  may  be- 
come liable  to  another  such  party  subsequent  to  him,  notice 


THE  NEGOTIABILITY  OF  COMMERCIAL  PAPER      35 

of  dishonor  may  also  be  passed  between  parties  secondarily 
liable  under  rules  too  detailed  for  consideration  here. 

The  rights  of  the  parties  secondarily  liable,  to  have  pre- 
sentment take  place  and  have  notice  of  dishonor  sent  them, 
may  be  waived  by  them.  A  waiver  to  this  effect  is  some- 
times embodied  in  the  wording  of  a  bill  or  note,  or  is  printed 
over  the  place  on  the  back  for  indorsements.  In  this  case  all 
general  indorsers  agree  to  the  waiver.  If  a  waiver  is  writ- 
ten in  with  his  indorsement  by  an  individual  indorser  him- 
self, it  is  his  individual  waiver  only.  In  the  case  of  a  long 
bill  dishonored  for  non-acceptance,  the  right  of  reimburse- 
ment in  the  sum  of  the  full  face  value  of  the  instrument 
takes  immediate  effect  and  is  not  held  in  abeyance  until  the 
date  of  maturity  of  the  instrument. 

A  protest  is  a  formal  certificate  of  dishonor,  and  to 
protest  means  to  secure  this  certificate.  A  notary  public  is 
usually  procured  to  make  the  certificate  of  protest  and  in 
it  he  cites  the  legally  relevant  facts  of  the  dishonor,  and 
thus  creates  evidence  independent  of  the  mere  word  of 
the  holder  himself.  This  certificate  may,  however,  be  made 
by  any  reputable  resident  of  the  place  where  the  instru- 
ment is  dishonored,  in  the  presence  of  two  or  more  credible 
witnesses.  Under  the  American  and  the  British  law,  a 
foreign  bill  of  exchange  must  be  protested  at  the  time  of 
its  dishonor  if  the  drawer  or  the  indorsers  are  to  be  bound. 
The  statute  defines  a  foreign  bill  as  other  than  an  inland 
bill,  and  the  latter  as  "a  bill  which  is  or  on  its  face  purports 
to  be  both  drawn  and  payable  within  this  state"  ("Uniform 
Law"  §213).  In  a  legal  sense,  a  bill  drawn  by  a  person 
in  New  Jersey  on  one  in  New  York  is  a  foreign  bill.  While 
in  the  case  of  notes  and  inland  bills,  protest  is  not  tech- 
nically necessary,  it  is  often  secured  nevertheless  to  serve 
as  better  evidence  of  the  facts  of  presentment  and  dishonor 
than  the  mere  affirmation  of  the  holder  himself. 

A  person  may  negotiate  a  bill  or  note  and  still  avoid 


36  FOREIGN  EXCHANGE 

indorser's  liability:  and  this  in  two  ways.  First,  if  the 
instrument  is  payable  to  bearer,  he  may  effect  the  negotia- 
tion by  the  mere  act  of  delivery  without  indorsement,  pro- 
vided the  party  taking  from  him  is  willing  to  receive  the 
instrument  without  his  indorsement.  Second,  he  may  give 
a  "qualified"  indorsement  or  indorsement  "without  re- 
course." But  he  has  certain  other  liabilities  of  which  he 
cannot  divest  himself  in  these  ways.  The  negotiation  of  a 
bill  or  note  constitutes  a  sale,  and-  the  transferor  in  his 
capacity  as  a  vendor  or  seller  makes,  by  implication  of  law, 
certain  warranties  concerning  the  instrument  he  sells. 
These  were  at  first  simply  the  vendor's  warranties  deter- 
mined by  the  common  law  relating  to  the  sale  of  goods  and 
chattels,  but  are  now  expressly  listed  in  the  Negotiable 
Instruments  Law  as  follows:  "Every  person  negotiating 
an  instrument  by  delivery  or  by  a  qualified  indorsement, 
warrants:  (1)  That  the  instrument  is  genuine  and  in  all 
respects  what  it  purports  to  be;  (2)  that  he  has  a  good 
title  to  it;  (3)  that  all  prior  parties  had  capacity  to  con- 
tract; (4)  that  he  has  no  knowledge  of  any  fact  which 
would  impair  the  validity  of  the  instrument  or  render  it 
valueless.  But  when  the  negotiation  is  by  delivery  only, 
the  warranty  extends  in  favor  of  no  holder  other  than  the 
immediate  transferee"  ("Uniform  Law"  §115).  A  ven- 
dor's warranty  amounts  to  a  representation,  whether  ex- 
pressed or  implied,  as  to  the  character  of  the  article  sold, 
which  representation  under  the  law  takes  the  position  of  a 
condition  of  the  agreement  of  sale.  Under  the  statute  the 
implied  warranties,  or  the  warranties  implied  in  the  mere 
act  of  negotiation,  are  those  set  forth  in  the  section  just 
quoted.  The  obligation  of  the  seller  of  the  instrument 
under  these  warranties  is  to  make  good  to  the  buyer  any 
pecuniary  damage  which  he  may  suffer  by  reason  of  any 
of  the  representations  proving  untrue.  The  measure  of  this 
damage,  briefly  stated,  is  the  difference  between  what  the 


THE  NEGOTIABILITY  OF  COMMERCIAL  PAPER      37 

holder  is  actually  able  to  obtain  from  the  instrument  under 
a  failure  of  the  representations,  and  what  he  would  have 
received  had  all  the  representations  proved  true.  We  can- 
not develop  these  matters  at  any  length,  but  before  passing 
on  may  give  one  illustration  which  may  help  bring  out  their 
meaning.  Suppose  an  instrument  sold  by  A  to  B  is  a 
forgery  without  A  having  knowledge  of  the  fact,  and  sup- 
pose A  indorsed  to  B  "without  recourse."  When  the  facts 
are  exposed  and  collection  from  the  ostensible  principal 
obligor  becomes  impossible  (since  he  has  an  absolute  de- 
fense), B  cannot  have  recourse  on  A  as  an  indorser,  but 
he  may  get  damages  from  A  as  a  vendor,  on  the  grounds 
of  the  failure  of  A's  (implied)  representation  that  the  in- 
strument was  genuine.  If  B  could  have  come  back  on  A 
as  the  giver  of  an  unqualified  indorsement,  he  would  have 
been  entitled  to  collect  the  full  face  value  of  the  instru- 
ment. When  he  comes  back  on  A  in  fact  as  a  vendor,  he 
can  claim  instead  damages,  probably  not  far  from  the  same 
sum. 

To  summarize,  the  indorser 's  obligation  (when  he  be- 
comes charged  with  it)  is  to  pay  the  full  face  or  maturity 
value  of  the  instrument  on  demand  (1)  to  any  holder  sub- 
sequent to  himself  who  has  been  unable  to  obtain  payment 
from  the  principal  obligor  or  drawee,  as  the  case  may  be, 
or  (2)  to  any  indorser  subsequent  to  himself  who  has  had 
to  pay  the  instrument  under  this  rule.  The  regular  in- 
dorser is  also  a  seller  of  the  instrument  and  he  is  liable 
under  the  vendor's  warranties.  Speaking  now  merely  of 
liabilities,  a  general  indorsement  (or  one  not  qualified  by 
the  words  ''without  recourse")  has  the  effect  simply  of 
adding  the  indorser 's  to  the  vendor's  liabilities.  With  re- 
gard to  presentment,  dishonor,  and  notice  of  dishonor,  the 
technical  requirements  explained  in  the  preceding  pages  as 
necessary  for  binding  the  parties  secondarily  liable,  are 
necessary  for  fastening  upon  these  parties  their  liabilities  as 


&  FOREIGN  EXCHANGE 

indorsers,  but  are  not  necessary  to  hold  them  to  their  ven- 
dor's liabilities.6 

5  A  classification  of  parties  liable,  common  in  legal  treatises  and 
given  for  instance  in  Norton  on  Bills  and  Notes  (3d  ed.,  p.  157), 
differs  from  the  one  advanced  in  our  text,  in  that  it  places  the 
drawer  of  a  bill  prior  to  its  acceptance  among  the  parties  primarily 
liable.     Thus: 

Parties  Primarily  Liable: 
The  maker  of  a  note. 
The  acceptor  of  a  bill. 
The  drawer  of  a  bill,  prior  to  its  acceptance. 

Parties  Secondarily  Liable: 

The  indorser  of  either  a  note  or  a  bill. 

The  drawer  of  a  bill,   subsequent  to   its   acceptance. 

Here  the  drawer  of  a  bill  while  the  instrument  is  still  not  accepted 
is  thought  of  as  primarily  liable  because  (apart  from  indorsers, 
and  there  may  be  no  indorsers)  he  is  the  only  person  in  fact  liable. 
And  the  drawer's  liability  is  considered  to  become  secondary  only 
after  acceptance  has  provided  the  bill  with  some  one  else  as  the 
party  primarily  liable. 

The  issue  between  the  classifications  depends  upon  the  meaning 
given  the  word  "primarily."  But  the  classification  presented  in  our 
text  would  seem  to  be  agreeable  to  the  language  of  the  statute, 
which  says  "the  person  'primarily'  liable  on  an  instrument  is  the 
person  who  by  the  terms  of  the  instrument  is  absolutely  required 
to  pay  the  same.  All  other  parties  are  'secondarily'  liable"  (§3). 
Xothing  could  be  more  obvious  than  that  the  drawer  of  an  unac- 
cepted bill  is  not  absolutely  bound  to  pay  it.  He  is  bound  solely 
on  the  condition  of  presentment,  dishonor,  and  notice.  He  is 
secondarily  liable.  There  is  no  party  primarily  liable.  The  asso- 
ciation of  the  drawer  of  an  unaccepted  bill  with  makers  and  ac- 
ceptors is  unfortunate  and  misleading  to  say  the  least,  because  the 
character  of  his  liability  is  not  theirs  at  all  but  on  the  contrary  is 
that  of  the  indorsers"! 


CHAPTER  III 
DISCOUNT  AND  INTEREST 

§  13.  Future  sum  and  present  price. — An  understanding 
of  the  elements  of  the  subject  of  discount  and  interest  is 
essential  to  the  student  of  the  exchanges.  In  this  book  it 
will  not  be  necessary  to  make  the  explanations  on  this  topic 
run  back  into  the  foundations  of  the  phenomenon  of  in- 
terest on  capital.  We  may  take  our  start  from  the  premise 
that  every  loan,  advance,  or  investment  of  money,  under- 
taken as  a  "business"  venture,  is  made  with  the  hope  that 
it  will  yield  that  type  of  gain  known  as  interest.  Every 
operation  of  this  character  involves  an  outlay  of  money  (or 
of  money's  worth)  for  a  deferred  return  in  money  (or 
money's  worth).  The  outlay  may  consist  in  a  single  item 
of  expenditure  made  all  at  one  time,  as  in  the  case  of  the 
price  paid  for  a  bond  or  a  note ;  or  it  may  consist  in  a  plural 
number  or  series  of  expenditures  made  at  various  intervals, 
regular  or  irregular,  as  in  the  case  of  most  investments  in 
actual  properties  as  distinguished  from  those  in  securities. 
The  return  also  may  consist  in  a  single  item  of  receipts,  or 
in  a  plural  number  or  series  of  such  items.  Interest  calcu- 
lations are  simplest  in  form  where  the  outlay  and  return 
are  both  single  items,  as  happens  usually  to  be  the  case 
where  short-term  commercial  paper  is  involved.  In  deal- 
ings in  this  paper,  the  outlay  consists  in  the  price  paid  for 
a  note  or  a  bill,  or  in  the  amount  loaned  when  a  note  is 
taken,  and  it  is  practically  universal  for  this  outlay  to  be 
paid  over  in  a  single  sum  all  on  one  day.  The  return  con- 
sists in  wnat  is  received  from  the  purchased  note  or  bill, 

39 


40  FOREIGN  EXCHANGE 

or  from  repayment  of  the  loan,  usually  an  amount  repaid 
as  a  single  item  in  the  sense  that  it  is  all  repaid  on  one 
day  or  at  one  time.  The  return  in  any  number  of  types  of 
investment  is,  of  course,  made  up  of  a  series  of  future  re- 
ceipts. In  the  case  of  long-term  money  contracts,  interest 
at  least  is  always  payable  in  installments,  and  sometimes 
principal  is  so  paj'able. 

We  shall  feel  justified  here  in  confining  our  attention  to 
the  problem  of  interest  and  discount  as  it  appears  where 
there  is  a  single  outlay  followed  by  a  single  return,  except 
that  we  should  give  a  word  to  the  bank  loan  with  interest 
payable  in  installments.  To  illustrate  such  a  loan  suppose 
the  Bank  of  A  lends  John  Doe  $1,000  for  one  year  at  an 
interest  charge  of  5%  per  annum  payable  quarterly.  The 
outlay  and  returns  of  the  bank  in  this  operation  will  evi- 
dently be  as  follows: 

Outlay  Returns 

On  first  of  year $1,000      End  of  first  quarter    $     12.50 

End  of  second  quarter        12.50 
End  of  third  quarter  12.50 

End  of  fourth  quarter  1,012.50 

The  interest  for  a  year  is  5%  of  $1000,  or  $50,  and  this 
divides  into  quarterly  installments  of  $12.50  each.  The 
$1012.50  due  at  the  end  of  the  fourth  quarter  is  the  $12.50 
of  interest  then  payable  plus  the  $1,000  of  principal,  also 
payable  at  precisely  the  same  time.  The  borrower  in  this 
illustration  would  probably  give  the  bank  his  note  for  $1,000 
bearing  interest  at  5%  payable  quarterly.  The  bank  in 
effect  buys  this  note  for  $1,000  on  the  day  of  its  issue.  In 
doing  this  it  makes  an  investment  at  5%.1  (A  slight 
change  in  the  illustration  would  make  the  calculation  of  the 

i  The  rate  of  interest  earned  in  this  investment  is  strictly  speaking 
5%  per  annum  compounded  quarterly,  which  is  a  slightly  higher 
rate  than  5%  simple  interest. 


DISCOUNT  AND  INTEREST  41 

rate  of  interest  earned  in  this  investment  a  somewhat  more 
complex  question.  Suppose  the  bank  bought  this  note  for 
$980  on  the  day  of  its  issue.  The  outlay  would  now  be 
$980  instead  of  a  thousand,  but  the  returns  would  remain 
unchanged  as  shown  in  the  schedule.  The  rate  of  interest 
named  in  the  note  would  be  5%,  but  the  rate  of  interest 
earned  in  the  investment  made  by  buying  the  note  would 
be  very  close  to  7.28%  simple  interest,  or  better  than  71/4%. 
Examination  of  this  type  of  problem  would  involve  us  in 
too  lengthy  a  consideration  of  interest.) 

"We  shall  deal  henceforth  only  with  the  case  of  the  single 
outlay  and  single  return.  We  may  call  the  outlay  made 
to  buy  a  bill  or  note,  the  present  price,  and  the  return 
which  the  instrument  pays  at  maturity,  the  future  sum. 
It  remains  to  point  out  that  with  respect  to  the  wording 
of  an  instrument  there  are  two  ways  of  expressing  or  in- 
dicating the  future  sum.  For  this  sum  may  be  set  forth 
(1)  simply  and  directly  as  such,  or  (2)  as  a  "principal 
sum"  plus  contractual  interest  at  a  specified  rate.  To 
illustrate,  the  following  two  notes  promise  the  same  future 
sum,  but  express  this  sum  in  the  two  different  ways. 

[1] 
$1,010.00  New  York,  N.  Y.,  July  1,  1916. 

Sixty  days  after  date,  I  promise  to  pay  to  the  order  of 
William  Hill,  One  Thousand  and  Ten  Dollars. 

James  Alexander. 

[2] 
$1,000.00  New  York,  N.  Y.,  July  1,  1916. 

Sixty  days  after  date,  I  promise  to  pay  to  the  order  of 
William  Hill,  One  Thousand  Dollars  with  interest  at  the  rate  of 
6%  per  annum. 

James  Alexander. 

Since  the  interest  promised  in  the  second  of  these  notes 
is  $10,  both  instruments  have  precisely  the  same  maturity 


12  FOREIGN  EXCHANGE 

value.     The  following  acceptance  by  James  Alexander  will 
also  be  a  practical  equivalent  of  either  of  these  notes. 

$1,010.00  Sr         vjj^Boston,  Mass.,  Jane  28,  1916. 

Sixty  days  differ  kight  Jfpay  to  the  order  of  myself 

One  Thousand  anafTeni Dollars,  and  charge  to  my  account. 

y  / 

To  James  AlexaMrr,^^  _ 

100  Broadly,     A  fiht^t^^A^ 

New  York  Cit#.  rf4&C~*~»^  '"^ 

Only  one  of  the  three  instruments  given  here  is  an  inter- 
est-bearing contract  in  the  sense  that  a  part  of  what  it 
promises  to  pay  is  called  interest  by  name  in  the  words 
of  the  contract.  Neither  the  first  note  nor  the  acceptance 
bear  interest  in  this  sense.  They  do  not  promise  $1,010  plus 
interest  for  sixty  days  at  some  rate  or  other  (as  the  legal 
rate  in  the  state  in  question),  but  promise  this  sum  with- 
out addition  of  any  sort.  To  give  them  this  effect  it  is 
not  legally  required  that  these  instruments  should  contain 
the  phrase  "without  interest,"  though  the  presence  of 
these  words  will  do  no  harm.2  The  actual  rate  of  interest 
made  in  an  investment  in  any  one  of  these  instruments 
depends  on  the  price  paid  for  it,  and  with  the  same  price 
paid  on  the  same  date  this  rate  of  interest  will  be  the  same 
no  matter  which  one  is  purchased.     If  $1,000  is  paid  for 

2  Discussions  of  the  law  governing  the  obligation  to  pay  interest 
before  maturity,  and  after  the  due  date  on  overdue  instruments,  may 
be  found  in  the  leading  legal  texts  on  bills  and  notes.  See  also  the 
articles  on  "Interest"  in  the  "Century  Digest,"  or  in  the  "American 
and  English  Encyclopedia  of  Law,''  or  in  other  similar  compilations. 
"Where  no  interest  is  reserved  [i.e.,  specified]  in  a  note  it  will  draw 
interest  after  maturity  at  the  legal  rate,"  [i.e.,  the  rate  set  by 
statute].     Randolph,   "Commercial  Paper,"   §  1712. 


DISCOUNT  AND  INTEREST  43 

any  one  of  the  three  on  July  1st,  the  buyer  makes  an  in- 
vestment at  6%.  If  $1003.31  were  paid,  he  would  make 
an  investment  at  4%. 

As  regards  business  custom,  notes  appear  in  both  the 
non-interest-bearing  and  the  interest-bearing  form.  Where 
a  note  is  given  to  a  bank  at  the  time  of  a  straight  loan  for 
a  designated  period,  it  is  likely  to  be  written  in  the  in- 
terest-bearing form.  Where  it  is  prepared  for  sale  at  the 
best  present  price  obtainable  in  the  money  market  it  is 
most  suitable  it  should  be  in  the  non-interest-bearing  form 
and  be  ready  for  sale  at  a  discount  rate.  So  far  as  the 
writer's  knowledge  extends,  the  regular  type  of  bill  of  ex- 
change which  is  dischargeable  in  a  stipulated  sum  of  the 
money  of  the  country  where  it  is  payable,  never  takes  the 
form  of  an  interest-bearing  contract,  no  matter  what  its 
term  of  life.  That  is,  it  never  names  a  "principal  sum" 
which  is  to  be  paid  with  an  addition  of  interest  for  elapsed 
time  at  a  specified  rate.  It  simply  names  in  full  the  amount 
payable  at  maturity.3  The  reader  understands  of  course 
that  an  allowance  on  account  of  interest  is  made  whenever 
any  long  bill  is  purchased,  by  the  simple  method  of  re- 
ducing the  price  paid  for  it.4 

§  14.  The  rate  of  discount  and  the  rate  of  interest. — The 
negotiation  of  a  bill  or  note  prior  to  its  maturity  is  a  virtual 
sale  of  a  future  sum  of  money.  This  sale  takes  place  at 
a  reduced  present  price.  Discount  may  be  defined  as  the 
amount  deducted  from  a  future  sum  to  arrive  at  its  present 
price.  Damaged  commodities  sold  at  a  reduction  from  a 
list  price  are  said  to  be  offered  at  a  discount.  A  depre- 
ciated currency  circulating  at  a  rate  below  its  par  in  some 
other  form  of  money  is  said  to  be  at  a  discount.  Thus 
there  are  various  kinds  of  discounts,  but  the  discount  which 

s  For  a  special  type  of  bill  of  exchange  with  an  Interest  elauso 
see  the  one  described  in   §  72. 

*  See  second  problem  in  part  B  of  §  16. 


1 1  FOREIGN  EXCHANGE 

concerns  ns  here  and  which  is  a  variant  form  of  interest, 
is  a  deduction  made  for  futurity.  The  futurity  of  an 
amount  due  on  an  obligation  is  a  sort  of  detrimental  cir- 
cumstance. On  account  of  it  something  is  "knocked  off" 
a  future  sum  to  find  its  present  equivalent. 

The  rate  of  discount  is  the  percentage  per  annum  which 
the  discount  bears  to  the  future  sum;  or  again,  it  is  the 
difference  between  any  specified  future  sum  and  its  present 
price,  expressed  as  a  percentage  per  annum  of  the  future 
sum.  To  illustrate,  if  X  sells  Y  an  acceptance  upon  which 
$1,000  is  due  in  sixty  days,  for  a  consideration  of  $990 
present  cash,  ten  dollars,  or  the  difference  between  these 
two  quantities,  is  the  discount  on  $1,000.  It  is  the  dis- 
count for  a  deferment  of  the  future  sum  by  one-sixth  of 
a  year.  Discount  is  proportional  to  time  to  elapse,  and 
this  is  a  discount  at  a  rate  of  $60  for  a  full  year.  $60 
being  6%  of  $1,000,  the  "rate  of  discount"  is  6%.  We 
come  to  the  same  result  by  reasoning  that  $10  is  1%  of 
$1,000,  and  that  if  a  1%  discount  is  deducted  for  a  defer- 
ment of  one-sixth  of  a  year,  6%  is  deducted  by  the  year 
or  per  annum. 

If  A  should  lend  B  $990  for  one-sixth  of  a  year  on  the 
understanding  that  B  should  pay  back  $1,000  in  complete 
discharge  of  the  loan,  we  would  speak  of  the  $10  excess 
of  the  amount  returned  above  the  amount  advanced,  as 
the  "interest"  on  the  amount  advanced.  $10  is  here  the 
interest  on  the  $990  for  a  sixth  of  a  year.  This  interest 
is  then  running  at  a  rate  of  $60  to  the  year.  60  is  6%oo% 
of  990,  and  the  rate  of  interest  is  6eAoo%,  contrasting  with 
the  rate  of  discount  which  is  6%  with  the  same  future 
sum  and  present  price. 

The  loan  by  A  to  B  is  just  as  much  the  giving  of  a 
present  price  for  a  future  sum  as  was  the  purchase  by  Y 
of  the  acceptance  from  X.  In  both  cases  we  have  a  per- 
son giving  up  $990  of  present  money  to  receive  $1,000 


DISCOUNT  AND  INTEREST  45 

deferred  one-sixth  of  a  year.  In  one  case  the  difference 
between  these  two  quantities  is  spoken  of  as  interest,  in  the 
other  as  discount.  It  appears  then  (always  confining  our- 
selves to  the  case  of  the  single  outlay  for  the  single  de- 
ferred .return)  that  interest  is  the  difference  between  a 
future  sum  and  its  present  price  when  this  difference  is 
thought  of  as  a  fraction  of  the  present  price,  and  discount 
is  the  identical  difference  when  thought  of  as  a  fraction  of 
the  future  sum.  To  summarize:  the  difference  between  a 
future  sum  and  its  present  price  expressed  as  a  percentage 
per  annum  of  the  present  price  is  the  rate  of  interest,  and 
expressed  as  a  percentage  per  annum  of  the  future  sum 
is  the  rate  of  discount.  The  rate  of  discount  is  not  always 
conceived  of  in  precisely  this  way,5  but  this  is  in  fact  the 
correct  definition  of  that  rate  reduced  to  its  ultimate  and 
simplest  terms. 

§  15.  Illustrative  problems. — Practical  problems  of  dis- 
count and  interest  may  be  divided  into  two  classes.  In 
one  class  the  rate  of  discount  or  the  rate  of  interest  is 
given  among  the  data,  in  the  other  the  question  is  to  find 
one  of  these  rates.  A  number  of  specimen  problems  are 
put  and  solved  in  this  section.  For  the  sake  of  conven- 
ience, we  shall  follow  the  more  common  American  method 
of  treating  the  year  as  360  days,  and  shall  not  assume 
days  of  grace,  these  having  been  abolished  under  the  Amer- 
ican Uniform  Negotiable  Instruments  Law.  (In  England 
the  year  is  handled  as  being  365  days,  and  days  of  grace, 
three  in  number,  are  allowed  by  law  on  all  time  bills  and 
notes  unless  grace  is  waived.)  Using  the  term  "money 
rate"  to  signify  either  a  discount  or  an  interest  rate, 
group  A  of  the  following  problems  consists  of  those  with 
the  money  rate  given  among  the  data. 

6  Compare  §  17. 


46  FOREIGN  EXCHANGE 

A. 

(1)  An  interest  problem. — Given  a  loan  of  $5,000  for  three 
calendar  months  or  for  90  days  (both  being  treated  as  ^th  year) 
with  interest  at  5%,  what  sum  will  be  required  to  discharge  the 
loan  at  maturity? 

Interest  for  one  year  on  $5,000  at  5%  would  be 
%oo  or  .05  x  5,000  or  $250.00 

Interest  for  90  days  e=  XA  x  250  or  62.50 

Amount  required  to  discharge  the  loan: 

Principal     $5,000.00 

Plus  interest   62.50 


$5,062.50    Answer. 

If  the  question  were,  "What  is  the  amount  due  at  ma- 
turity on  a  90  daj's'  note  for  $5,000,  bearing  interest  at 
5%  ?"  we  should  get  the  same  answer  by  the  same  method. 

(2)  A  discount  problem. — A  90  days  sight  bill  for  $20,000  is 
bought  by  a  banker  on  the  day  of  acceptance  on  the  basis  of  a 
discount  rate  of  4%.  What  does  the  banker  give  for  the  bill,  or 
what  are  the  proceeds  or  "avails"  of  the  discount? 

On  the  day  of  the  discount  the  bill  has  90  days  or  }4th  year 

to  run. 
The  discount  for  a  year  would  be  4%  of  $20,000, 

or  .04  x  20,000 $800 

The  discount  for  y4th  year  =  &  X  800  = 200 

The  price  paid  for  the  bill : 

The  future  sum    $20,000 

The  discount    200 


$19,800     Answer. 

It  is  evident  we  may  also  find  the  discount  as  follows: 

Discount  for  one  year  =  4%. 
Discount  for  ^th  year  =  l%. 
1%  of  20,000  =  200. 


DISCOUNT  AND  INTEREST  47 

(3)  An  interest  problem. — With  the  same  bill  and  same  date 
of  purchase  as  in  question  2,  suppose  the  banker  buys  the  instru- 
ment at  a  price  to  yield  him  a.  rate  of  interest  of  4%,  what  would 
he  pay  for  it?  (This  question  might  be  worded,  what  is  the 
true  present  worth  of  this  bill  on  the  basis  of  an  interest  rate 
of  4%?) 

The  price  paid  for  the  bill  is  the  banker's  outlay,  and 

the  amount  received  on  it  at  maturity  is  his  return. 
With  the  rate  of  interest  at  4%  per  annum,  the  interest 

for  90  days  will  amount  to  1%. 
Therefore  the  return  must  exceed  the  outlay  by  1%  of 

the   outlay    (i.e.,  there  must  be   a  l^o    gain   on   the 

outlay). 
The  return  then  =  101%  of  the  outlay. 
Therefore  the  outlay  must  be  —  of  the  return. 

^j  X  $20,000  =     $19,801.98.     Answer. 

Another  statement:     There  must  be  $1.01  of  return  for 

each    $1.00     of    outlay,     and    20000     contains    1.01, 

19801.98   times,    and   therefore    for   20000    of   return 

there  must  be  19801.98  of  outlay. 

The  present  price  of  the  bill  in  question  is 

on  a  4%  discount  rate $19,800 

on  a  4%  interest  rate   19,801.98 

(4)  A  discount  problem. — What  would  a  90  days'  sight  bill 
for  £20,000  sell  for  in  England  on  the  day  of  acceptance,  on  the 
basis  of  a  4%  discount  rate? 

The  bill  has  93  days  to  run,  there  being  three  days  of 

grace. 
The   discount    for   one   year   would   be   4%    of 

£20,000  or £800.00 

The  discount  for  93  days  is  °y305  X  800  or 203.84 

The  future  sum £20,000 

The  discount    203.84 


Price  paid  for  the  bill  £19,790.16   (£19,796  3s.  2d.) 

in  -n  .,        «  %  Answer. 

(Compare  with  problem  2.) 


FOREIGN  EXCHANGE 

(5)  A  discount  problem. — What  would  a  90  days'  sight  bill  for 
$20,000  sell  for  50  days  after  acceptance  on  the  basis  of  a  dis- 
count rate  of  4%  ? 

The  bill  has  40  days  to  run. 

The    discount    for    a    year    would    be    4%    of 

$20,000  or $800.00 

The  discount  for  40  days  is  4%eo  or  %  of  800  or    88.89 
The   price  of  the   bill  =  $20,000  —  $88.99  =  $19,911.11 

Answer. 

(6)  A  discount  problem. — What  would  a  60  days'  note  for 
$1,200,  bearing  interest  at  5%,  sell  for  on  the  basis  of  a  4%  dis- 
count rate,  if  sold  on  the  date  of  issue  of  the  note? 

The  amount  due  at  maturity,  or  future  sum,  is  found  as 
follows : 

Principal    $1,200.00 

Nominal  interest  %  of  5%  of  $1,200       10.00 


Future  sum  $1,210.00 

One  year's  discount  on  $1,210  at  4%  would  be.  .$48.40 

One-sixth  of  a  year's  discount  is  therefore 8.07 

Sale  price  of  note: 
Future  sum  or  maturity  value  . .  .$1,210.00 
Discount    8.07 


Answer  $1,201.93 

(7)  An  interest  problem. — What  can  be  paid  for  the  above 
mentioned  note  on  the  day  of  its  issue,  if  the  buyer  is  to  gain 
interest  at  8%  on  his  investment  in  the  note  (assuming  he  holds 
to  maturity)  ? 

The  maturity  value  or  future  sum  is,  as  before . .  $1,210 
Interest  at  8%  per  annum  means  1%%  for  60  days    or 

%th  year) 
Therefore  the  gain  on  the  outlay  must  come  to  1%%  of 

the  outlay 
Or  $1,210   (the  return)   must  exceed  the  outlay  by  this 

1%%  and  be  101%%  of  the  outlay. 


DISCOUNT  AND  INTEREST  49 

The  outlay  itself  (or  100%)  must  be 
10°,  X  i*210'  which,  being  solved,  equals  $1,194.08 

Answer. 
B. 

(1)  A  discount  problem. — An  accepted  bill  of  exchange  for 
$5,000  payable  in  90  days  is  sold  to  a  banker  for  $4,937.50. 
What  rate  of  discount  did  the  banker  charge? 

The  future  sum=      $5,000.00 
The  present  price  =    4,937.50 


62.50  the  difference,  is  the  discount 
for  one-fourth  year. 
4. 


$250.00  the  discount  per  annum. 

The  question  becomes,  what  per  cent,  is  250  of  5,000? 

1%  of  5,000  =  50 

250  -r-  50  =  5 

250  is  5%  of  5,000. 
Therefore  the  rate  of  discount  was  5%.     Answer. 

(2)  An  interest  problem. — What  rate  of  interest  did  the  banker 
make  in  his  investment  in  this  bill,  assuming  that  he  held  it  till 
maturity? 

The  answer  will  be  very  close  to  5%  and  above  5%. 
The  practical  man  will  usually  consider  it  unnecessary 
to  find  the  answer  to  this  question. 

The  future  sum  or  return  = $5,000.00 

The  present  price  or  outlay 4,937.50 

The  difference 62.50 

This  is  the  interest  on  the  outlay  for  Vi  year. 
4  X  62.50  =  250.00  =  the  interest  for  1  year. 
The  question  becomes,  what  per  cent,  is  250  of  4,937.50 
(the  outlay)  1 

1%  of  4,937.50  =  49.375 

250 -=-49.375  =  5.063  4- 


50  FOREIGN  EXCHANGE 

250  is  5.063%  of  the  outlay, 

and   the   rate   of   interest   in   the   investment   is 
5.063%     Answer. 

(3)  A  discount  problem. — A  6  months'  note  for  $1,000,  bear- 
ing interest  at  6%,  is  sold  to  a  banker  for  $1,019.70  when  it  has 
3  months  yet  to  run.  It  being  known  that  the  banker  bought  on 
the  basis  of  a  discount  rate,  what  was  this  rate? 

$1,000        the  principal  sum  of  the  note. 

the  contractual  or  nominal  interest  would  be 
V2  of  6%  of  1,000,  or  30. 
30        the  contractual  interest. 


1,030       the  future  sum,  or  amount  due  at  maturity. 
1,019.70  the  price  paid  by  the  banker 


10.30  the  discount  for  3  months  or  ^th  year. 
The  question  becomes,  what  %  is  10.30  of  1,030  (or  the 
future  sum),  for  this  multiplied  by  4  will  give  the  dis- 
count rate  per  annum. 
10.30  is  1%  of  1,030. 

4Xl%=4%,  the  rate  of  discount.     Answer. 
(The  rate  of  interest  earned  in  the  banker's  investment 
is  in  this  case 4.06  -(-  % ) . 

(4)  An  interest  problem. — A  banker  lends  Smith  $1,000  for 
60  days,  charging  interest  at  the  rate  of  5%,  and  takes  Smith's 
60  days'  note  for  $1,000,  bearing  interest  at  5%.  30  days  later 
the  banker  sells  this  note  to  a  large  bank  on  the  basis  of  a  3^% 
discount  rate.  What  rate  of  interest  does  the  first  banker  make 
in  his  investment  in  this  note? 

Find  the  banker's  outlay  and  return. 

The  outlay  is  the  amount  handed  over  at  the  time 

the  note  was  received,  or  the  amount  of  the  loan,  $1,000. 
The  return  is  the  price  received  for  the  note  in  the  sale 
to  the  large  bank. 

To  calculate  this  price : 

Principal  of  note 1,000.00 


DISCOUNT  AND  INTEREST  51 

Interest  due  on  it   8,33 

(%th  of  5%  of  1,000)      

Maturity  value  of  note 1,008.33 

There  are  30  days  (or  ^th  year)  to  run  on  the 

note  at  the  time  of  sale,  and  the  discount  taken 

out  by  the  large  bank  will  be  M2th  of  3V2%  of 

1,008.33,  which  is  2.94. 

Future  sum  1,008.33 

Discount    2.94 

Sale    price     of    note,     and 
first  banker's  return 1,005.39 

Final  step. 

The  return    1,005.39 

The  outlay    1,000.00 

The  interest    5.39 

If  interest  of  5.39  is  earned  in  Vi2th  year,  or  the 
time  during  which  the  first  banker  held  the 
note,  the  interest  per  annum  is  12  X  5.39,  or 
64.68  per  year. 

The  question  becomes,  "What  per  cent,  is  64.68 
of  1,000? 

1%=10 

64.68-^-10  =  6.468,  and  therefore  64.68  = 
6.468%  of  1,000. 

Answer     6.468% 

"Whether  the  rate  of  discount  is  given  in  a  problem,  or 
whether  it  is  to  be  found,  it  is  always  the  difference  between 
the  future  sum  and  the  present  price  expressed  in  the 
form  of  a  percentage  per  annum  of  the  future  sum.  The 
rate  of  interest  is  always  this  same  difference  counted  as 
a  percentage  per  annum  of  the  present  price  or  outlaj'. 

When  a  banker  quotes  a  customer  a  money  rate,  as  say 
4%,  it  does  not  make  a  great  difference  whether  it  is  a 
discount  or  an  interest  rate,  provided  the  rate  itself  is  a 


52  FOREIGN  EXCHANGE 

moderate  one  and  the  period  of  the  advance  is  not  unusually 
long.  The  existence  of  the  discount  rate,  as  a  variant  upon 
the  interest  rate,  is  not  to  be  accounted  for  so  much  by 
reason  of  its  giving  the  money  lender  a  somewhat  higher 
gain  as  by  reason  of  its  superior  convenience  in  calculation. 
Almost  always  we  find  discount  rates  in  use  only  where  they 
are  more  convenient  than  interest  rates.  A  discount  rate 
is  virtually  always  employed  in  connection  with  a  bill  of 
exchange,  and  an  interest  rate  is  generally  employed  in 
connection  with  a  straight  loan,  and  always  in  connection 
with  deposits  which  are  paid  earnings  by  the  banker  hold- 
ing the  deposits,  that  is,  of  course,  in  connection  with  what 
we  call  ''interest-bearing  deposits." 

§  16.  The  terminology  of  discount  and  interest. — It  is 
proper  to  explain  that  several  meanings  attach  to  the 
word  "discount."  Used  as  the  verb,  to  discount,  the  word 
signifies  either  to  purchase  or  to  sell  a  long  bill  or  note  at 
a  present  price  calculated  on  the  basis  of  a  specified  rate 
of  discount.  Both  the  buyer  and  the  seller  of  the  paper 
are  spoken  of  as  "discounting"  it.  There  is  a  somewhat 
similar  usage  in  speaking  of  both  landlord  and  tenant  as 
renting  a  house.  The  price  received  by  the  person  making 
the  sale  of  the  bill  or  note  is  sometimes  called  the  "avails" 
of  the  discount,  meaning  the  proceeds  of  the  sale  of  the 
paper. 

One  who,  having  bought  a  piece  of  long  paper,  makes 
a  resale  of  it,  is  said  to  rediscount  it.  Banks  to  which  such 
resales  are  often  made  are  called  banks  of  rediscount. 
Examples  are  the  Bank  of  England  and  other  central  bank- 
ing institutions  in  Europe,  and  the  new  Federal  Beserve 
Banks  of  the  United  States. 

Bills  and  notes  which  have  been  purchased  by  an  insti- 
tution regularly  engaged  in  discounting  and  which  are 
carried  as  a  part  of  its  assets,  are  often  called  its  discounts. 
The  largest  item  of  resources  of  a  commercial  bank  is  thus 


DISCOUNT  AND  INTEREST  53 

frequently  entitled  "loans  and  discounts"  or  sometimes 
"discounts"  simply.  Here  the  pieces  of  paper  themselves, 
or  at  any  rate  the  claims  which  they  represent,  are  called 
discounts.  A  firm  whose  chief  activity  is  the  purchase  of 
long  paper  is  sometimes  called  a  discount  house.  This 
term  is  used  more  in  London  than  elsewhere. 

The  phrases  "bank  discount"  and  "true  discount"  re- 
quire mention.  The  former  when  it  appears  is  a  mere 
synonym  for  what  we  have  called  simply  discount.  The 
latter  is  a  synonym  for  interest. 

The  rate  of  interest  actually  expressed  in  those  instru- 
ments which  name  a  rate,  may  be  called  ' '  explicit ' '  interest. 
The  rate  of  interest  really  gained  in  making  an  invest- 
ment in  long  paper,  depending  on  the  price  paid  for  the 
paper  (whether  or  not  an  express  rate  is  named),  may  be 
called  "implicit"  interest,  or  better  the  implicit  rate  of 
interest.  This  is  the  rate  implied  in  the  price  paid  for  a 
given  future  sum.6  The  explicit  rate  of  interest  is  also 
called  the  "nominal"  rate,  and  the  implicit  is  called  the 
"effective"  or  "investment"  rate,  and  also  the  "yield." 
Problem  number  A7  in  the  preceding  section  illustrates  this 
distinction.  It  was  a  case  of  a  5%  note  bought  at  a  price 
yielding  the  investor  an  actual  rate  of  interest  of  8%. 
5%  is  a  "nominal"  rate  in  the  sense  that  it  is  the  rate 
in  name  only,  the  "real"  rate  being  8%. 

§  17.  Discount  conceived  of  as  interest  in  advance. — 
Bankers  often  refer  to  the  taking  of  discount  as  the  "taking 
of  interest  in  advance."  This  usage  has  found  its  way 
into  the  courts  (see  for  example,  Black  v.  The  First  Na- 
tional Bank,  96  Md.  399).  We  can  best  explain  the  thoughl 
here  by  presenting  first  the  three  examples  shown   below. 

(i  The  terms  "explicit"  and  "implicit"  interest  are  suggested  1)} 
Irving  Fisher  in  his  book,  "The  Rate  of  Interest"  p.  G. 


54  FOREIGN  EXCHANGE 

Example  A 

Interest  Payable  in  the  Ordinary  Way,  Namely  at  the 
Time  of  Repayment  of  the  Loan 

Loan  of  $1,000  made  on  July  1st  for  3  months,  interest  at  6%. 

Amount  paid  over  by  bank  to  borrower  on  July  1 $1,000 

Amount  repaid  by  borrower  on  October  1 1,015 

Found  as  follows : 

Principal     1,000 

Interest    15 

(Vi  of  6%  of  1,000) 


1,015 


Here  the  future  sum  is  $1,015  and  its  present  price,  or 
the  present  amount  exchanged  for  it,  is  $1,000. 

The  difference  between  the  two  is  $15,  which  is  l1/4% 
of  the  present  price,  or  6%  of  it  per  annum.  That  is, 
this  is  a  case  of  an  interest  rate  of  6%  per  annum,  as  we 
have  defined  the  interest  rate. 

Example  B 

Interest  Payable  in  Advance,  or  at  the  Beginning  of  the 

Loan 

Loan  of  $1,000  made  on  July  1st  for  3  months,  "interest  in  ad- 
vance" at  6%. 

Amount  paid  by  bank  to  borrower  on  July  1st $    985 

Found  as  follows: 

Amount  loaned  on  July  1st  by  bank.  .1,000 
3  months'  interest  at  6%  payable  in 
advance  or  on  July  1 15 


Net  amount  paid  over  to  borrower.  . .    985 

Amount  paid  back  by  borrower  on  October  1 1,000 

Since  the  borrower  has  already  paid  the  $15  of  interest, 
he  does  not  pay  it  again  at  the  end,  but  repays  merely 
the  principal  of  the  loan,  or  $1,000. 


DISCOUNT  AND  INTEREST  55 

Here  the  banker  gains  $15  for  a  quarter  year's  investment 
of  $985  and  the  true  rate  of  interest  figures  to  6.09%  per 
annum. 

Example  C 

An  Ordinary  Discount  Operation 

Suppose  a  bill  for  $1,000  payable  October  1st,  is  discounted  on 
July  1st  at  6%  (discount  rate). 

Amount  paid  by  bank  to  the  seller  of  the  bill $    985 

Found  as  follows: 

Future  sum  due 1,000 

Discount     15 

(i/4  of  6%  of  future  sum)  

985 

Amount  received  back  by  bank  at  maturity 1,000 

Here  the  bank  invests  $985  for  a  quarter  year  and  receives  a  re- 
turn of  $1,000,  yielding  a  gain  of  $15. 

This  is  a  case  of  a  6%  discount  rate,  and  a  true  interest  rate 
of  6.09% 

The  perfect  equivalence  of  operations  B  and  C  can  be 
seen  at  a  glance.  When  in  operation  B,  the  banker  thinks 
of  himself  as  lending  $1,000  at  interest  payable  in  ad- 
vance, what  he  really  does  is  to  lend  $985  for  a  return 
of  $1,000  in  one-fourth  year.  But  if  he  discounted  $1,000 
due  in  one-fourth  year,  on  the  basis  of  a  discount  rate 
of  6%,  he  would  make  precisely  the  same  outlay  for  the 
same  return.  The  conception  that  discount  is  interest  in 
advance  is  sound  enough,  but  it  is  less  simple  than  the  con- 
ception explained  in  this  text. 


CHAPTER  IV 
COMMERCIAL  BANKING 

§  18.  The  functions  of  the  commercial  bank. — The  central 
figure  among  the  dealers  in  commercial  paper  and  ex- 
change is  the  commercial  bank.  Readers  who  seek  an 
acquaintanceship  with  the  subject  of  the  foreign  exchanges 
are  likely  to  be  familiar  with  the  nature  and  operations 
of  this  institution,  but  a  brief  exposition  of  the  rudiments 
of  banking  is  presented  at  this  point  for  those  who  may 
desire  it.  It  is  certainly  necessary  for  the  student  of  the 
exchanges  to  understand  at  least  so  much  as  is  told  here. 
He  ought  to  understand  more. 

While  ' '  banking ' '  signifies  everywhere  some  form  of  deal- 
ing in  money  or  securities,  the  exact  meaning  of  the  term 
differs  according  to  time,  place,  and  context.  But  speak- 
ing for  the  United  States  and  England,  and  for  the  pres- 
ent time,  a  commercial  bank  may  be  defined  as  an  insti- 
tution which  (1)  receives  demand  deposits  and  (2)  makes 
short  term  loans,  as  a  regular  activity  at  an  established 
place  of  business.  It  is  the  combination  of  these  two  lines 
of  money-dealing  that  makes  commercial  banking.  It  is 
from  this  combination  that  the  possibility  arises  of  a  bank's 
lending  more  money  or  funds  than  it  itself  owns  in  its  own 
right.  This  is  what  gives  banking  its  distinctive  character, 
and  the  pursuit  of  either  of  these  lines  of  business  singly 
does  not  in  the  least  constitute  banking. 

All  banks,  however,  engage  in  a  certain  number  of  other 
operations  more  or  less  akin  to  these  two  major  ones.  The 
most  noteworthy  among  these  are   (1)   buying  and  selling 

56 


COMMERCIAL  BANKING  57 

exchange,  domestic  and  foreign,  (2)  buying  and  selling  gold 
and  silver  bullion,  and  foreign  coins,  (3)  receiving  specific 
deposits  (i.e. — deposits  of  articles,  including  moneys  if  the 
depositor  sees  fit,  with  the  understanding  that  the  identical 
articles  are  to  be  returned  to  the  depositor),  (4)  making 
collections  on  notes  and  drafts  for  customers,  distinguished 
from  the  purchase  or  discount  of  these  instruments,  and 
(5)  acting  as  attorney-in-fact.  The  issue  of  bank  notes 
to  be  used  as  currency,  while  an  important  branch  of  the 
business,  is  not  an  essential  part  of  commercial  banking. 
In  this  country  banks  with  national  charters  issue  these 
notes,  and  the  state  banks  do  not,  but  both  classes  are 
engaged  in  commercial  banking. 

§  19.  Deposits  and  reserve. — In  technical  banking  usage 
the  word  "deposit"  does  not  signify  the  money,  or  the 
credit  instrument,  handed  in  to  the  receiving  teller,  that 
is,  the  thing  deposited,  but  means  the  credit  which  the 
customer  gets  on  the  bank's  books  by  reason  of  turning  in 
the  money  or  its  equivalent.  The  deposit  is  the  customer's 
right  to  demand  payment,  or  his  credit,  and  it  is  at  the 
same  time  the  bank's  liability  to  make  payment,  or  its  debt. 

When  receiving  funds  on  deposit,  a  commercial  bank 
engages  with  the  customer  that  the  amount  clue  him  will  be 
paid  on  demand,  but  the  bank  does  not  engage  that  it  will 
keep  all  or  any  particular  proportion  of  his  money  actually 
on  hand  for  the  purpose.  The  bank  becomes  the  customer's 
debtor,  and  not  a  mere  agent  for  holding  his  money.  If  a 
bank  owes  say  $100,000  of  demand  deposits  at  a  given 
moment,  it  may  find  that  by  keeping  $20,000  of  actual 
money  on  hand,  it  will  be  able  in  fact  to  meet  all  daily 
demands.  The  depositors  collectively  do  not,  except  in 
cases  of  "runs,"  demand  all  they  have  a  right  to.  On 
some  days,  as  a  body  they  bring  in  more  than  they  with- 
draw. On  other  days  the  reverse  is  true.  The  bank  knows 
that  by  keeping  a  certain  amount  of  cash  on  hand  it   can 


58  FOREIGN  EXCHANGE 

hold  the  fort  against  the  demands  that  will  be  made  on  it. 
In  ease  withdrawals  persistently  exceed  depositing,  the 
bank  will  have  to  arrange  to  convert  some  of  its  assets,  other 
than  cash,  into  cash.  "Whatever  cash  the  bank  does  have 
on  hand  at  any  moment  for  the  purpose  of  meeting  its 
demand  liabilities,  is  known  as  its  reserve.  A  certain 
amount  of  reserve  is  essential  for  safety.  Its  quantity  may 
be  expressed  either  in  the  absolute  amount  of  dollars 
(pounds,  francs,  etc.)  or  in  the  percentage  which  this 
amount  bears  to  the  total  of  demand  liabilities  protected 
by  the  reserve.  The  latter  is  of  course  the  more  signifi- 
cant figure.  Often  banks  are  recpiired  to  keep  a  certain 
minimum  percentage  of  reserve.  "Where  this  is  the  case, 
the  requirement  does  not  flow  from  a  contract  with  the 
depositors,  but  from  legislation  by  the  government  under 
whose  jurisdiction  the  bank  does  business.  Such  legisla- 
tion  is   common. 

§  20.  The  loans  and  their  limits. — The  making  of  short 
term  loans  and  advances  is  the  second  part  of  the  whole 
which  constitutes  commercial  banking.  As  indicated  on 
an  earlier  page,  these  advances  may  be  made  directly  to 
the  customer  in  return  for  his  promissory  note,  or  in- 
directly by  the  discount  for  him  of  the  obligations  of  others 
held  by  him.  The  commercial  bank  is  to  be  regarded 
simply  as  the  greatest  of  the  buj'ers  or  discounters  of  com- 
mercial paper.  "While  the  deposits  of  a  bank  constitute  its 
chief  liability,  the  "loans  and  discounts"  are  its  chief 
asset  or  resource.  The  beginner,  thinking  of  the  bank's 
lending  as  an  act  of  passing  out  cash  to  the  borrower,  is 
inclined  to  regard  the  making  of  a  loan  as  a  means  of 
reducing  resources.  But,  of  course,  in  making  advances 
or  loans,  the  institution  receives  promissory  notes  or  bills 
of  exchange  upon  which  various  persons  are  liable  to  pay 
it  money  at  maturity.  In  the  usage  of  the  bank  state- 
ment, the  words  "loans  and  discounts"  mean,  not  the  cash 


COMMERCIAL  BANKING  59 

passed  out  (if  cash  is  passed  out),  but  the  claim  against 
outside  persons  which  the  bank  holds  in  virtue  of  the  pos- 
session of  these  notes  and  bills.  Look  through  its  portfolio 
of  notes  and  bills  and  you  see  the  paper  evidences  of  the 
credits  of  the  bank  against  outsiders,  which  constitute  the 
greatest  single  item  among  its  resources. 

The  operation  of  making  a  loan  does  not  necessarily 
cause  a  bank  an  immediate  loss  of  cash,  nor  a  loss  equal 
to  the  amount  of  the  loan.  The  borrower  may  ask  for 
neither  cash  nor  a  draft  (or  exchange)  but  may  simply 
have  the  proceeds  of  the  loan  credited  to  his  deposit.  In 
fact,  deposits  in  great  part  arise  out  of  loans  or  advances. 
Since  a  loan  costs  interest,  a  customer  is  practically  cer- 
tain not  to  ask  for  one  until  he  is  ready  to  use  it,  and 
therefore  may  be  expected  to  draw  his  checks  against  it 
at  an  early  moment.  But  this  may  or  may  not  cause  the 
bank  an  immediate  loss  of  cash.  The  checks  may  be  drawn 
in  favor  of  other  customers  of  the  same  bank  who  simply 
deposit  them  without  demanding  cash.  But  on  the  aver- 
age, an  expansion  of  the  loans  means  a  loss  of  a  certain 
amount  of  cash.  Nevertheless,  the  bank  has  constantly 
far  more  funds  loaned  out  than  it  has  cash  on  hand. 

The  limits  beyond  which  the  lending  operations  of  a 
bank  may  not  be  extended  are  governed  at  bottom  simply 
by  the  minimum  limit  imposed  on  the  bank's  reserve, 
whether  imposed  by  law  or  by  the  bank's  own  prudence. 
If  a  bank's  circumstances  are  such  that  its  reserve  should 
not  be  allowed  to  fall  below  twenty  per  cent,  of  its  deposit 
liabilities,  then  the  limit  of  loans  is  reached  when  further 
lending  would  result  in  the  fall  of  the  reserve  below  this 
percentage.  For  every  loan  decreases  the  percentage  of  the 
reserve,  whether  the  loan  results  in  a  positive  loss  of  cash 
or  not.  If  the  loan  is  made  by  a  direct  out-payment  of 
cash,  the  absolute  amount  of  the  reserve  is  directly  reduced 
by  the  full  amount  of  the  loan.     If  the  loan  is  made  by 


60  FOREIGN  EXCHANGE 

giving  the  borrower  a  deposit  credit,  the  perceyitage  of  the 
reserve  is  still  reduced,  because  the  amount  of  deposits 
against  which  the  reserve  is  carried  is  increased.  Suppose 
a  bank  had  deposits  of  $100,000  and  a  reserve  of  $20,000. 
If  a  loan  of  $10,000  were  made  it  would  necessarily  de- 
crease the  reserve  percentage.  If  $10,000  cash  were  paid 
out  the  reserve  would  drop  from  $20,000  and  20%  to 
$10,000  and  10%.  If,  on  the  other  hand,  a  $10,000  credit 
were  granted  the  borrower,  the  deposits  would  ascend  to 
$110,000.  The  $20,000  reserve  would  then  come  to  but 
18711%  of  the  deposits.  This  drop  of  19ii%  is  the  slightest 
fall  in  the  reserve  that  can  result  from  the  loan  of  $10,000. 
A  decline  of  this  extent  will  be  produced  even  if  the 
borrower's  checking  against  his  account  occasions  no  sub- 
sequent withdrawals   of   cash. 

There  is  then  a  limit  to  the  amount  which  a  bank  may 
lend,  because  there  is  a  limit  below  which  it  dares  not 
force  the  percentage  of  its  reserve.  The  bank's  motive  to 
expand  its  loans  rests  on  the  fact  that  the  interest  which 
they  yield  is  the  chief  element  in  its  earnings.  In  addi- 
tion to  the  restriction  on  their  quantity,  there  is  another 
important  one  pertaining  to  the  character  of  loans,  which 
is  that  they  must  be  for  short  periods.  It  is  true,  com- 
mercial banks  buy  a  certain  amount  of  investment  bonds, 
presumably  of  a  readily  marketable  type,  and  this  consti- 
tutes the  making  of  long-term  loans  (of  a  saleable  character 
however),  but  the  far  greater  portion  of  their  advances 
must  be  for  short  periods  and  must  be  properly  marshalled 
or  arranged  according  to  the  dates  of  their  maturities. 
Cash  reserve  normally  covers  only  a  minor  fraction  of  the 
demand  liabilities,  the  greater  volume  of  the  cover  consist- 
ing in  these  short  term  loans  and  advances.  It  would  be 
dangerous  for  a  bank  to  make  long  loans  and  fixed  invest- 
ments with  funds  which  it  might  have  to  return  to  de- 
positors at  any  time.     To  explain  what  is  meant  by  saying 


COMMERCIAL  BANKING  61 

that  the  loans  should  be  properly  marshalled,  suppose 
a  bank  has  $100,000  of  loans  outstanding,  the  latest  of 
which  to  mature  are  payable  90  days  from  the  present  date^ 
Some  of  these  loans  ought  to  be  falling  due  to-day,  some 
to-morrow,  some  the  next  day,  and  so  on.  That  is,  the  ideal 
arrangement  for  the  whole  series  (special  circumstances 
apart)  is  to  have  the  maturities  flow  in  continuously  and 
evenly.  This  operates  to  give  the  bank  a  ready  command 
of  cash  in  case  of  persistent  withdrawals  of  deposits.  In 
ordinary  circumstances  it  can  maintain  the  body  of  out- 
standing loans  as  a  constant  by  making  renewals  and  new 
advances  (if  the  market  for  them  is  present1)  equal  each 
day  to  the  amount  of  loans  maturing  that  day.  But  if 
excessive  withdrawals  take  place,  the  reduction  of  renewals 
and  new  advances  will  create  a  cash  income  to  meet  or 
help  meet  the  needs  of  the  case.  The  chief  points  to  learn 
in  this  connection  are  that  the  protection  or  cover  which  the 
commercial  bank  carries  against  its  deposits,  consists  first, 
in  a  partial  cash  reserve,  and  second,  in  a  portfolio  of 
short  term  loans  and  advances  properly  marshalled,  and 
after  these  in  other  assets. 

1  In  the  long  run  the  market  can  be  expanded  by  a  sufficient  re- 
duction in  discount  and  interest  rates,  or  by  the  same  token,  can  be 
maintained. 


CHAPTER  V 
THE  RATES  OF  EXCHANGE 

§  21.  The  general  character  of  dealings  in  exchange. — 
The  bill  of  exchange,  taken  in  its  legal  sense  as  including 
checks  and  bank  drafts,  is  the  virtually  exclusive  means  of 
international  payment  employed  by  ordinary  merchants. 
If  a  merchant  in  New  York  purchases  dry-goods  from  one 
in  London  for  a  stipulated  price  of  £10,000,  his  full  legal 
obligation  is  to  place  in  the  hands  of  the  Englishman  £10,000 
of  British  legal  tender.  But  in  virtue  of  the  system  of  the 
foreign  exchanges,  the  New  York  merchant  is  in  practice 
enabled  to  settle  his  account  with  economy  and  ease,  merely 
by  obtaining  a  bill  of  exchange.  If  it  were  not  for  this 
system,  he  would  be  forced  to  ship  gold  to  London  for  con- 
version into  British  coin  to  satisfy  his  legal  tender  obliga- 
tions there.  But  in  fact  the  shipment  of  gold  by  mere 
merchants  is  wholly  avoided.  It  is  true,  some  gold  has  to 
be  shipped  between  countries  from  time  to  time,  but  the 
amount  of  such  shipments  is  by  the  use  of  exchange  reduced 
to  a  minimum.  And  when  made,  the  shipments  are  engi- 
neered by  bankers  only,  and  ordinary  merchants  do  not 
have  to  think  about  them. 

"We  do  not  mean  to  imply  that  the  economy  in  the  use  of 
specie,  which  is  effected  by  means  of  credit  instruments, 
is  confined  to  foreign  commerce.  Checks  and  drafts  per- 
form the  same  function  in  internal  as  in  foreign  trade.  If 
it  were  not  for  the  system  of  domestic  exchange,  a  San 
Francisco  merchant  indebted  to  one  in  Chicago  would  be 
compelled  to  ship  money   (although  not  necessarily  gold) 

62 


THE  RATES  OF  EXCHANGE  63 

from  San  Francisco  to  Chicago.  In  their  very  fundamen- 
tals, the  principles  of  foreign  and  of  domestic  exchange 
are  the  same.  Nevertheless  in  many  respects  the  two  sys- 
tems of  exchange  are  dissimilar.  The  single  fact  that  dif- 
ferent countries  have  different  kinds  of  money,  makes 
foreign  exchange  a  distinct  subject  in  practical  detail.  One 
consequence  of  this  is  that  the  economy  in  the  use  of  specie 
effected  in  foreign  trade  is  not  only  more  striking  to  the 
imagination  but  is  actually  more  important  than  in  domes- 
tic exchange.  When  the  coin  of  one  gold-standard  country 
is  shipped  to  another,  it  has  to  be  melted  down  and  recoined 
if  it  is  to  become  money  of  that  other  country.1  In  addi- 
tion to  this,  such  coin  when  melted  into  bullion  will  fre- 
quently require  to  be  restandardized  before  being  recoined. 
This  will  always  be  the  case  when  gold  %o  fine  is  shipped  to 
a  country  having  gold  ai/i2  fine,  and  vice  versa.  There  is 
more  business  and  expense  associated  with  an  international 
than  with  a  domestic  shipment  of  money. 

Foreign  exchange  in  any  given  country  consists  in  bills 
and  telegraphic  orders  to  pay  money  that  are  dischargeable 
in  some  other  country.  Hereafter,  unless  the  contrary  is 
indicated,  we  may  be  understood  as  meaning  foreign  ex- 
change when  we  speak  simply  of  exchange.  The  buyers 
and  sellers  of  exchange  include  merchants  engaged  in  for- 
eign trade  and  dealers  in  bonds  and  stocks  for  foreign 
account,  governments  and  corporations  that  owe  money 
abroad  or  are  owed  it  from  abroad,  travelers,  immigrants, 
miscellaneous  persons,  and  the  bankers.  Among  all  these 
there  are  discernible  two  broad  groups,  namely   (1)  those 

i  Sometimes,  however,  coin  of  one  country  shipped  to  another  will 
he  held  in  its  existing  form,  though  valued  only  as  bullion,  against 
the  possible  turn  of  the  tide  of  gold  movement  when  it  may  be 
shipped  back  to  the  first  country  to  be  available  there  without  thp 
expense  of  recoinage.  And  again  specie  export  often  takes  place 
without  involving  the  melting  of  coin,  because  uncoined  bullion  ia 
found  for  shipment. 


.il  FOREIGN  EXCHANGE 

who  deal  in  exchange  as  a  business  in  itself,  that  is,  bankers, 
"exchange  houses,"  and  sometimes  bill  brokers,  and  (2) 
those  who  deal  in  exchange  as  an  incident  to  some  other 
major  transaction,  operation,  or  undertaking,  such  as  an 
export  or  import  of  goods  or  securities,  a  flotation  or  dis- 
charge of  a  foreign  loan  or  the  payment  of  interest  upon 
it,  a  tour,  and  so  forth.  Traders — by  this  we  mean  traders 
in  merchandise  and  securities — are  of  course  by  far  the 
most  important  element  in  the  second  group.  The  trans- 
actions in  the  exchange  market  fall  into  two  main  classes, 
(1)  those  taking  place  between  the  traders  and  the  bankers 
(with  the  intermediation  of  bill  brokers  at  times)  and  (2) 
those  taking  place  between  banker  and  banker.  No  im- 
portant dealings  in  exchange  are  carried  on  directly  be- 
tween merchant  and  merchant  without  the  intervention  of 
the  banker  as  a  middleman.  For  the  present  we  shall  pass 
over  with  mere  mention  the  extensive  traffic  in  drafts  and 
telegraphic  transfers  which  the  banks  conduct  among 
themselves,  but  it  would  seem  wise  to  give  some  general  in- 
dications of  the  character  of  the  dealings  which  originate 
with  the  traders,  before  we  enter  upon  the  chief  subject 
of  this  chapter,  the  quotation  of  rates. 

International  business  transactions  in  merchandise  and 
securities  make  necessary  certain  exchange  operations  as 
a  means  of  settlement.  The  main  relations  of  these  trans- 
actions to  the  exchange  market  may  be  stated  in  brief  as 
follows : 

An  export  from  a  country  either  increases  the  supply  of  ex- 
change for  sale  in  that  country,  or  it  does  not  directly  affect 
the  market  for  exchange  in  the  country. 

An  import  into  a  country  either  increases  the  demand  for  ex* 
change  in  that  country,  or  it  does  not  directly  affect  its 
market  for  exchange. 

One  county's  export  is  the  other  country's  import.  The 
importer  becomes  a  commercial  debtor,  the  exporter  a  com- 


THE  RATES  OF  EXCHANGE  65 

mercial  creditor.  The  kind  of  money  that  is  due  from  the 
one  to  the  other,  depends  on  the  manner  of  quoting  the 
price  of  the  article  exported.  It  will  be  foreign  money 
if  the  price  was  stated  in  foreign  money,  and  home  money 
if  it  was  quoted  in  the  latter  medium.  In  either  case 
the  exporter  will  manage  through  some  operation  in  ex- 
change to  make  final  payment  take  the  form  of  his  home 
currency.  The  exchange  operation  to  be  utilized  in  a 
settlement  and  the  method  of  quoting  prices  exercise  much 
influence  upon  each  other.  To  be  brief  though  explicit, 
there  are  three  chief  modes  of  settlement  by  means  of  ex- 
change.    These   are 

(1)  The  exporter  draws  on  the  importer's  countrj7.2 

(2)  The  importer  remits3  to  the  exporter's  country. 

(3)  The  exporter  draws  on  some  third  country  and  the  im- 

porter  (or  a  bank  acting  for  him)   also  remits  to  that 
third  country. 

For  purposes  of  illustration  let  us  suppose  a  shipment  of 
flour  from  New  York  by  way  of  one  of  the  French  ports 
to  Paris.  In  the  case  of  the  first  two  methods  we  may 
assume  the  price  of  the  consignment  to  be  50,000  francs. 
(1)  With  plan  number  one  in  operation,  the  New  York 
exporter  draws  a  draft  for  50,000  francs,  the  drawee  being 
either  (a)  the  French  importer  or  (b)  some  French  bank 
which  the  latter  has  induced  to  serve  as  drawee.  (The 
reasons  for  securing  a  bank  to  serve  as  drawee  will  be 
brought  to  light  in  a  later  chapter.)  The  exporter  then 
sells  this  draft  in  New  York  for  as  many  dollars  as  it 
will  fetch  at  the  current  rate  of  exchange.4     These  dollars 

2  To  draw  on  a  country  means,  of  course,  to  draw  on  some  person, 
firm,  corporation,  or  bank  in  that  country. 

3  To  remit  signifies  here  to  send  exchange  to  some  person  or  firm, 
corporation,  or  bank  in  the  country  in  question. 

1  In  practice  an  exporter's  draft  will  nearly  always  be  a  long  or 
time  bill  "with  documents  attached"  (see  especially  Chapter  VI). 
If   it   is  an   authorized   draft   on   a   bunk    it   will   be   readily   salea'uj 


6(i  FOREIGN  EXCHANGE 

are  his  compensation  in  its  final  form  for  the  flour  he  has 
shipped.  The  francs  surrendered  by  the  Frenchman  when 
he  honors  the  draft  (or  when  he  reimburses  the  bank  for 
paying  it  in  case  the  latter  was  drawee)  are  what  he  on 
his  side  gives  up  to  get  the  flour.  Between  the  exporter 
as  drawer  and  seller  of  the  draft  and  the  importer  as  the 
part}'  to  bear  the  ultimate  expense  of  discharging  it,  there 
stands  a  series  of  banks  that  handle  the  instrument.  (2) 
Under  the  second  plan,  the  Frenchman  expends  the  50,000 
francs  payable  by  him,  for  a  draft  on  New  York,  purchasing 
as  many  dollars  of  this  exchange  as  can  be  had  at  the 
current  rates,  and  remits  the  same  to  the  exporter.  Here 
as  before,  the  Frenchman  gives  up  francs,  the  American 
receives  dollars,  and  the  flour  is  paid  for.  Here  as  be- 
fore, a  chain  of  banks  intervenes  in  the  process  of  settle- 
ment. (3)  In  our  illustration  of  the  third  method  we  shall 
assume  the  price  of  the  consignment  of  flour  to  be  quoted 
in  American  money,  and  to  be,  say,  $9,650.  Here  we  shall 
suppose  the  French  merchant  arranges  for  a  "sterling 
credit"  in  favor  of  the  New  York  exporter.  This  will 
involve  the  grant  by  some  English  bank  of  a  permission 
to  the  American  to  draw  a  bill  or  bills  upon  it  against 
shipment  of  flour  to  the  Frenchman.  This  permission  will 
be  secured  by  the  Frenchman,  usually  through  the  inter- 
mediation of  a  French  banking  establishment.  (§  37  to  §  47 
of  this  book  are  given  over  to  the  explanation  of  this  scheme 
of  settlement.)  To  make  a  long  story  short,  this  plan 
means  that  at  the  time  of  shipment  the  American  exporter 
draws  a  draft  on  an  English  bank  for  a  sufficient  number 
of  pounds  sterling  to  sell  at  the  current  rates  of  exchange 

in  New  York.  If  when  drawn  on  the  importer  personally,  as  under 
method  number  one,  it  could  not  be  sold  in  New  York,  it  would  be 
given  to  a  New  York  bank  for  collection.  The  process  of  collection 
will  ultimately  bring  the  exporter  a  return  in  dollars,  and  of  course 
cost  the  Frenchman  francs. 


THE  RATES  OF  EXCHANGE  67 

for  the  9,650  dollars  due  him.  The  English  bank  pays 
this  draft  (which  under  standard  arrangements  will  be 
drawn  at  sixty  or  ninety  days  sight),  but  the  French  mer- 
chant— or  more  precisely  his  bank  acting  in  his  behalf  and 
taking  reimbursement  from  him — furnishes  the  pounds  re- 
quired to  discharge  the  instrument  by  buying  London  ex- 
change in  Paris  and  sending  it  over  to  the  English  bank. 
This  is  a  case  where  the  exporter  draws  on  a  third  country, 
and  the  importer,  or  a  bank  acting  in  his  behalf,  remits 
to  that  third  country.  All  cases  conform  to  the  rule  al- 
ready given,  that  the  exporter  either  draws  and  sells  ex- 
change or  does  not  engage  in  an  exchange  transaction  in 
his  country  (the  latter  being  the  case  under  plan  two), 
while  the  importer  either  buys  and  remits  exchange  or 
does  not  enter  the  exchange  market  of  his  country  (the 
latter  being  the  case  under  plan  one). 

To  summarize :  If  we  look  at  a  single  merchandise 
movement,  such  as  the  shipment  of  flour  from  the  United 
States  to  France,  we  see  that  it  may  function  (as  our 
export)  to  produce  in  our  market  a  supply  of  exchange  on 
France,  or  it  may  function  (as  a  French  import)  to  pro^ 
duce  in  France  a  demand  for  exchange  on  the  United 
States;  but  it  cannot  produce  both  of  these  effects  at  once. 
It  can,  however,  add  to  the  supply  of  exchange  in  America 
and  to  the  demand  for  exchange  in  France,  conjointly, 
where  the  exchange  is  in  both  cases  on  a  third  country. 
If  we  view  the  entire  commerce  of  a  given  country,  exports 
and  imports,  we  see  that  the  exports  give  rise  to  a  supply 
of  exchange  or  else  have  no  direct  effect  upon  its  ex- 
change market,  while  the  imports  create  a  demand  for 
exchange  or  else  have  no  direct 5  effect. 

There  are  a  number  of  variants  upon  the  three  chief 

6  Indirect  effects  may  be  produced  through  the  action  of  arbitrage  of 
exchange,  a  subject  discussed  in  Chapter  XIV. 


68  FOREIGN  EXCHANGE 

methods  of  settlement  upon  which  we  have  touched.  There 
is  much  to  be  said  concerning  the  practical  grounds  of 
choice  among  these  methods,  which  cannot  be  developed  at 
this  point  because  somewhat  advanced  questions  of  personal 
and  documentary  security  and  even  questions  of  arbitrage 
are  involved.  But  taking  the  commerce  of  the  world  at 
large,  it  is  safe  to  say  it  is  commoner  for  exporters  to  draw 
tli an  to  receive  remittances  of  exchange.  Particularly  in 
the  commerce  of  the  United  States  with  England,  it  is  the 
predominant  practice  for  our  exporters  to  draw  rather 
than  for  English  importers  to  remit,  and  it  seems  also 
commoner  in  this  case  for  our  importers  to  remit  rather 
than  to  be  drawn  upon  by  their  English  creditors.  These 
customs  have  the  effect  of  concentrating  the  exchange  deal- 
ings that  arise  out  of  the  commerce  between  the  two  coun- 
tries, on  the  American  side  or  in  our  market.  In  other 
words  we  traffic  a  great  deal  in  exchange  on  England  while 
the  English  deal  in  exchange  on  us  in  much  less  volume. 
This  condition  is  rather  characteristic  of  England's  com- 
merce with  all  countries.6  It  would  be  theoretically  pos- 
sible for  the  commerce  between  England  and  the  United 
States  to  be  settled  wholly  by  means  of  exchange  dealings 
on  our  side  and  by  supplementary  gold  shipments,  in  both 
directions  according  to  the  requirements  of  the  conditions, 
engineered  wholly  from  our  side  on  the  basis  of  our  ex- 
change rates. 

It  will  be  profitable  to  consider  further  the  manner  of 
utilizing  the  bill  as  a  means  of  international  payment.  We 
shall  give  next  a  simplified  illustration  of  its  employment, 
which  will  be  artificial  when  compared  with  actual  practice 
in  that  for  the  moment  it  leaves  out  of  consideration  the 
banker  as  exchange  middleman.     When  we  modify  the  illus- 


e  This  is  what  Mr.  George  Clare  has  reference  to  when  he  states 
that  "England  draws  few  bills  but  accepts  many,"  (see  his  "A  B  C 
of  the  Foreign  Exchanges,"  edition  of  1911,  p.  11). 


THE  RATES  OF  EXCHANGE  69 

tration  so  as  to  repair  this  defect,  we  can  show  most  easily 
the  way  in  which  the  banker  intervenes  and  the  essen- 
tial nature  of  his  operations  as  a  mere  middleman.  This 
will  still  leave  for  the  future,  an  explanation  of  his  serv- 
ices in  "financing"  commerce,  that  is,  his  services  in  mak- 
ing advances  to  merchants  in  connection  with  their  foreign 
shipments. 

Let  us  suppose  that  two  equal  and  opposed  commercial 
transactions  take  place  between  the  United  States  and 
England,  namely  (1)  an  export  of  our  flour  sold  in  Eng- 
land for  £10,000  and  (2)  an  import  of  their  dry  goods 
also  sold  our  merchant  for  £10,000.  It  would  be  possible 
for  one  bill  of  exchange  to  be  used  in  making  a  complete 
settlement  of  both  of  these  transactions.  For  the  sake  of 
simplicity  we  assume  at  present  that  the  bill  will  be  drawn 
payable  at  sight.  Settlement  could  be  accomplished  as 
follows : 

The  American  exporter  draws  a  bill  on  his  English  importer. 

He  sells  this  bill  to  the  American  importer. 

The  latter  in  turn  remits  it  to  his  creditor,  the  English  ex- 
porter. 

This  person  collects  payment,  on  the  bill  from  the  drawee  or 
English  importer. 

The  following  scheme  shows  the  plan  of  settlement  in 
greater  detail: 

The  American  Flour  Export  Company 

(1)  Ships  £10,000  wortli  of  flour  to  the  British  Flour  Import 

Company. 

(2)  Draws  a  sight  bill  on  the  latter  for  £10,000. 

(3)  Finds    as    a   purchaser   for    this    bill,    the    American    Dry 

Goods  Import  Company,  which  buys  it  at  a  price  say 
of  $4.85  per  pound  sterling,  paying  a  total  of  $48,500 
for  it. 


70  FOREIGN  EXCHANGE 

The  American  Flour  Export!  Company  has  now  received 
$48,500  for  its  flour  and  is  practically  out  of  the  settlement 
except  for  the  possibility  of  recourse  upon  it  as  drawer  in 
case  of  dishonor  of  the  bill.7 

The  American  Dry  Goods  Import  Company 

(1)  Receives  a  shipment  of  dry  goods  from  the  British  Dry 

Goods  Export  Company,  the  price  of  which  is  stipu- 
lated at  £10,000  in  English  money,  and  therefore  owes 
the  British  company  this  sum  of  sterling  money. 

(2)  Buys  the  above  mentioned  bill  of  exchange  for  $48,500. 

(3)  Indorses  this  bill  to  the  British  Dry  Goods  Export  Com- 

pany and  remits  it  to  this  company. 
The  American  Dry  Goods  Import  Company  is  now  practically 
out  of  the  settlement  except  for  the  possibilities  of  recourse. 

The  British  Dry  Goods  Export  Company 

(1)  Ships  the  consignment  of  dry  goods  already  mentioned. 

(2)  Is  therefore  creditor  of  the  American  Dry  Goods  Import 

Company  for  £10,000. 

(3)  Receives  the  above  mentioned  bill  of  exchange  from  the 

latter. 

(4)  Takes  the  bill  to  the  English  drawee,  namely  the  British 

Flour  Import  Company,  and  collects  from  it  £10,000  in 
payment. 
The  British  Dry  Goods  Export  Company  is  now  out  of  the 
settlement. 

The  British  Flour  Import  Company 

(1)  Receives  the  shipment  of  flour  already  mentioned. 

(2)  Becomes  a  debtor,  therefore,  to  the  American  Flour  Export 

Company  for  the  price  of  £10,000. 

(3)  Discharges  the  debt  by  paying  the  bill  of  exchange  for 

this  sum  drawn  by  the  latter. 

To  be  emphatic,  we  repeat  that  this  illustration  is  artificial 
in  two  respects.  In  the  first  place,  an  exchange  middleman", 
the  banker,  will  nearly  always  be  involved  in  practical  life, 

7  Compare  §   12. 


THE  RATES  OF  EXCHANGE  71 

and  therefore,  as  we  shall  see,  a  single  bill  will  not  ac- 
complish the  settlement.  In  the  second  place,  exporting 
merchants  will  almost  always  draw  long  instead  of  sight 
bills,  and  this  as  a  means  of  shifting  the  burden  of  financing 
the  shipment  to  the  shoulders  of  the  bankers  or  money 
lenders. 

But  taking  the  proceedings  as  given,  when  they  are  com- 
pleted both  commercial  transactions  are  settled.  Both  ex- 
porters have  been  paid  for  their  goods,  each  in  his  home 
money ;  and  both  importers  have  made  payment,  each  in  his 
home  money.  No  money  has  passed  between  the  two  coun- 
tries, but  a  sum  of  local  money  changed  hands  in  each 
country.  In  America  $48,500  was  transferred,  this  sum  de- 
pending on  the  rate  or  price  of  exchange,  and  £10,000  was 
transferred  in  England.  These  same  results  will  also  be 
secured  as  the  modified  settlement  is  worked  out  in  real  life. 

We  now  introduce  the  banker  as  exchange  middleman, 
while  retaining  the  assumption  that  a  sight  bill  is  drawn 
by  the  exporter.  Our  exporters  who  have  exchange  to 
sell  dispose  of  it  to  the  banks,  and  such  of  our  importers 
as  need  to  procure  exchange  obtain  it  from  the  banks. 
This  system  is  much  more  convenient  and  is  also  superior 
from  the  standpoint  of  credit  relations,  and  is  a  necessary 
incident  to  the  enjoyment  of  the  aid  of  the  banks  in  fi- 
nancing exports  and  imports.  The  banker  does  not  sell 
to  the  importers  the  same  bills  that  he  buys  from  the 
exporters!  He  is  not  like  the  produce  middleman  who 
perforce  sells  the  same  potatoes  that  he  buys.  The  banker 
sells  to  importers  new  sight  bills  or  checks  which  he  him- 
self draws.  The  system  is  simple.  The  banker  sends  his 
purchased  exchange  abroad  to  his  correspondent  bank,8 
with  which  he  has  a  deposit  or  "balance,"  and  has  this 
institution  collect  payment  and  place  the  proceeds  to  the 

s  Or  perhaps  to  a  branch  of  his  own  establishment  which  he  has 
abroad,  or  to  a  parent  institution  of  which  his  bank  is  a  branch. 


72  FOREIGN  EXCHANGE 

credit  of  his  deposit.  In  England  such  a  deposit  will, 
of  course,  be  in  pounds  sterling.  When  the  banker  comes 
to  sell  exchange,  he  draws  his  checks  on  this  deposit.  His 
purchases  of  exchange  build  up  his  foreign  balance  and  his 
sales  of  exchange  tear  it  down  again.  He  makes  the  two 
balance  or  cancel  one  another  in  the  long  run,  and  makes 
his  profits  out  of  a  difference  between  his  buying  and 
selling  rates.  In  brief  (1)  our  banker  buys  the  bills  drawn 
by  our  exporters,  (2)  remits  them  for  the  credit  of  his 
foreign  balance,  and  (3)  sells  his  checks  against  this  bal- 
ance to  our  importers.  (It  is  checks  he  sells  to  importers 
in  real  life,  and  not  his  long  bills.)  If  the  exchange  drawn 
by  the  exporter  is  a  long  bill,  as  it  is  usually,  the  banker 
sends  it  abroad  just  the  same.  He  receives  an  immediate 
credit  from  it  for  his  balance  (in  a  reduced  present  sum  of 
foreign  money)  if  he  has  it  discounted  abroad,  and  a  de- 
ferred credit  if  he  "invests"  in  it.9 

The  proceedings  in  the  illustration  with  which  we  have 
been  recently  dealing  on  the  assumption  that  no  banker  in- 
tervened, would  be  modified  by  his  entry  to  become  the 
following : 

The  American  Flour  Export  Company  draws  a  sight  draft  for 

£10,000  on  the  British  Flour  Import  Company. 
It  sells  this  draft  to  the  American  banker  for  say  $48,500. 
The  banker  remits  this  bill  to  his  London  correspondent  for 

credit. 
The  latter  collects  from  the  drawee  and  credits  the  remitting 

banker's  balance  with  £10,000. 
The  American  banker  sells  his  check  for  £10,000   drawn  on 

this    correspondent,    to    the    American    Dry    Goods    Import 

Company  for  perhaps  $48,510. 
This   company  remits   the   cheek  to  its   English   creditor,   the 

British  Dry  Goods   Export   Company,  which   collects  on  it 

from  the  English  correspondent  bank  on  which  it  is  drawn. 

9  Compare  Chapter  XI  on  investment  in  long  bills. 


THE  RATES  OF  EXCHANGE  73 

The  result  is,  both  exporters  have  been  paid  and  both 
importers  have  made  payment,  each  man  in  his  local 
money.10 

§  22.  The  methods  of  quoting  a  rate  of  exchange. — Ex- 
change rates  are  in  practice  quoted  according  to  three 
methods.  If  we  were  compelled  to  give  names  we  might 
call   them : 

(1)  The  premium  and  discount  method 

(2)  The  direct  price  method 

(3)  The  indirect  price  method. 

Any  rate  of  exchange  gives  us  what  is  essentially  a  price, 
namely  the  price  in  local  money  of  a  unit  of  money  payable 
on  order  at  another  place,  but  the  rate  does  not  necessarily 
assume  the  form  of  an  ordinary  price  quotation.  It  is 
for  this  reason,  no  doubt,  that  it  is  usual  to  speak  rather 
of  the  rate  than  the  price  of  exchange. 

Rates  of  domestic  exchange  are  quoted  in  the  premium 
and  discount  fashion.  This  holds  good  of  the  United 
States,  and  probably  of  all  countries.  Thus  at  some  mo- 
ment we  might  find  the  quotation  for  New  York  exchange 
as  "10^  discount"  in  Chicago  and  "35^  premium"  in 
San  Francisco,  signifying  the  discount  and  premium  per 
$1,000  face  value  of  sight  draft  on  New  York.  As  a  price 
the  Chicago  rate  would  read  $999.90,  and  the  San  Fran- 
cisco rate  would  read  $1000.35,  for  $1,000  of  draft.  Speak- 
ing of  the  practice  of  the  world  at  large,  foreign  exchange 
is  not  usually  quoted  according  to  the  premium  and  dis- 
count method.  However,  a  country  may  readily  adopt  this 
method  in  the  case  of  exchange  on  another  having  the 
same  monetary  unit,  as  Switzerland  on  France,  or  Eng- 
land on  South  Africa.     In  some  Central   American   coun- 

lOThe  services  and  compensation  of  correspondent  banks  are  con- 
sidered in  Chapter  VIII,  §  53. 


74  FOREIGN  EXCHANGE 

tries  the  quotations  of  exchange  on  foreign  places  having 
entirely  different  monetary  units  also  take  on  the  form  of 
a  percentage  of  premium. 

Under  what  we  have  ventured  to  call  the  direct  price 
method,  the  quotation  states  the  number  of  home  money- 
units  payable  for  1,  or  10,  or  perhaps  100  foreign  units. 
Taking  pre-war  figures,  sight  sterling  is  quoted  perhaps  in 
Berlin  at  20.40,  in  Paris  at  25.20,  in  New  York  at  4.85, 
the  figures  signifying  marks,  francs,  and  dollars  respec- 
tively per  pound  sterling.  Petrograd  formerly  quoted 
sterling  at  the  number  of  roubles   per  10   pounds. 

The  indirect  price  method  is  to  state  the  number  of 
foreign  units  that  may  be  purchased  or  sold  for  one  home 
unit.  This  method  is  common  only  where  the  country 
adopting  it  has  a  larger  (or  more  valuable)  money  unit 
than  the  country  on  which  the  exchange  so  quoted  is  drawn. 
London  rates  on  foreign  money  capitals  are  practically 
all  stated  after  this  fashion.  New  York  rates  on  Paris 
are  also  so  quoted.  If  New  York  quoted  sterling  in  this 
manner,  in  place  of  a  rate  of  4.85  we  would  find  the  figure 
of  491/6  (approximately)  signifying  491/&  English  pence 
of  exchange  purchasable  for  a  dollar.  To  refer  to  an  illus- 
tration given  by  the  Dutch  economist,  Pierson,  we  com- 
monly quote  sugar  at  so  many  cents,  say  6,  per  pound,  but 
we  could  quote  sugar  instead  at  16%  pounds  per  dollar. 
And  when  sugar  falls  from  6^  to  5^  per  pound  we  could 
also  say  that  it  has  fallen  from  16%  pounds  to  20  pounds 
for  a  dollar.  Thus  London  quotes  its  bills  on  Berlin  and 
Paris  and  other  continental  centers  in  the  manner  analogous 
to  the  quoting  of  sugar  at  20  pounds  per  dollar  instead  of 
at  5$  per  pound.  And  when  exchange  on  Berlin  or  Paris 
becomes  cheaper  in  London,  the  figure  expressing  the  rate 
goes  higher  and  vice  versa. 

§  23.  Specimen  market  reports. — Beneath  are  given  ex- 
amples of  exchange-market  reports.     The  first  is  from  the 


THE  RATES  OF  EXCHANGE  75 

Wall  Street  Journal,  a  daily  of  New  York  City,  and  shows 
rates  as  on  an  ordinary  day  prior  to  the  outbreak  of  the 
great  war. 

Foreign  Exchange 

The  foreign  exchange  market  opened  steady  with  demand  ster- 
ling at  4.8715  @  4.8720,  unchanged  from  Thursday's  close. 

The  market  was  quiet  throughout  the  day.  What  bills  were 
offered  were  quietly  absorbed  by  the  short  interest,  keeping  rates 
steady. 

At  the  close,  demand  sterling  was  4.8720  @  4.8725,  up  5 
points  on  the  day  from  the  opening. 


Cables 

Demand 

Sixty  Days 

Ninety  Days 

Sterling 

open 

4.8765  @  4.8770 

4.8715  @  4.8720 

4.83  @  4.8305 

4.8160  @  4.8165 

do 

closed 

4.8770  @  4.S775 

4.8720  @  4.8725 

4.S3  @  4.8305 

4.8160  @  4.8165 

Francs 

open 

5.171/4  plus  Me 

5.171/2 

5.19%  less  1/64 

do 

closed 

5.171/4  plus  1/16 

5.171/2 

5.19%  less  1/64 

Marks 

open 

95%  less  1/32 

953i6  less  %4 

91%  less  %2 

do 

closed 

95%  less  %4 

9554e 

947^  less  %4 

Guilders 

open 

40% 

do 

closed 

40i/s 

Paris  exchange  on  London  25  fr.  21  %c,  off  %c. 

Berlin  exchange  on  London  20m.  47  pf.,  unchanged. 

Rio  exchange  on  London  was  i/32d.  lower  and  quoted  at  15%2d.  against  15%2<i. 

last  year,  and  15  XA  d.  two  years  ago. 
London. 

Call  money  up  to  5%%,  closing  at  4%   to  5. 

Contingent  bought  bills  at  4%%. 

Prevailing  rate  at  close  was  4%%. 

The  next  report,  differing  somewhat  in  form,  is  from 
the  weekly,  Commercial  and  Financial  Chronicle  (New 
York).  The  table  shows  the  range  of  rates  for  a  week, 
also  as  under  ante-bellum  conditions. 

Foreign  Exchange. — Discounts  in  London  were  well  main- 
tained during  the  week,  yet  sterling  here  closed  lower  than  it 
was  quoted  a  week  ajjo. 

To-day's  (Friday's)  nominal  rates  for  sterling  exchange  were 
4.84  for  sixty  days  and  4.88  for  sight.  To-day's  actual  rates  for 
sterling  exchange  were  4.8320  @  4.8330  for  long,  4.8720  @  4.8725 
for  short  and  4.8770  @  4.8775  for  cables.  Commercial  on  banks 
4.8280   @   4.8290   and   documents    for   payment  4.82   (77)   4.82%. 


76  FOREIGN  EXCHANGE 

Cotton  for  payment  4.83  @  4.8314  and  grain  for  payment  4.83V4 
@  4.83i/2. 

To-day's  (Friday's)  actual  rates  for  Paris  bankers'  francs  were 
5.'20a  @  5.20  for  long  and  5.17y2d.  @  5.17V2  for  short.  Ger- 
many bankers'  marks  were  94716  @  94%c  for  long  and  95yi6  @ 
951/4d.  for  short.  Amsterdam  bankers'  guilders  40.12  @  40.14 
for  short. 

Exchange  at  Paris  on  London,  25f.  221/2C. ;  week's  range,  25f. 
22y2c.  high  and  25f.  2iy2c.  low. 

The  week's  range  for  exchange  rates  follows: 

Long  li  Short  12  Cables 

Sterling  Actual:  13 

High     4.8365  @  4.8375  4.8765  @  4.8775  4.88      @  4.8815 

Low     4.83      @  4.8310  4.8695  @  .4.8705  4.8750  @  4.8760 

Paris  Bankers'  Francs  : 

High     5.19%h  @  5.19%a  5.16%d  @  5.16%  5.16y4d  @  5.161,4 

Low     5.20a      @  5.20d  5.17y2d  @  5.17V2  5.16%d  @  5.16% 

Germany  Bankers'  Marks: 

High     947/iex    @  94  95i/4d      @  9514  95^      @  95%d 

.Low     94%        @  94%6d  95%6d    @  95?/I6  95y4x      @  959ifc 

Amsterdam,  Bankers'  Guilders: 

High     40.19       @  40.20  40.24       @  40.25 

Low     40.133,4  @  40.15  40.18       @  40.19 

Less  a    Vm  of  1%       d    y32  of  1%       h  %2  of  1% 

Plus  k    yi6  of  1%       x    y32  of  1%       y  %2  of  1% 

The  following  were  the  rates  for  domestic  exchange  on  New 
York  at  the  undermentioned  cities  to-day :  Chicago  5c  per  $1,000 
discount,  Boston  par.  San  Francisco  70c  per  $1,000  premium. 
Savannah,  buying  $1.50  per  $1,000  discount,  selling  par.  Mon- 
treal 3114c  per  $1,000  discount. 

The  following  table  from  the  New  York  Times'  "Annal- 
ist" for  November  20th,  1916,  shows  war-time  rates  in  New 
York.  Quotations  on  a  larger  number  of  countries  are 
now  published  in  our  metropolis  than  before  the  war. 

11  Long  means  here  drawn  at  sixty  days  sight. 

12  Short  means  here  sight  or  demand  drafts,  or  checks. 

is  "Actual"  rates  are  opposed  to  "posted"  rates.  See  page  82 
below. 


THE  RATES  OF  EXCHANGE  77 

Foreign  Exchange 

The  range  for  the  principal  exchanges  during  the  week  were 

as  follows : 

Per  ct. 

Range  Week  Ended  Disc.  I—) 

Nov.  18.  or  pre- 

Par.               High.           Low.  Close.  mium  (+) 

Sterling    - 4.8665             4.75"/i6         4.75%  4.75«A6  —   2.2 

Francs     5.1826             5.84%              5.84%  5.84%  —12.8 

Marks      95.28               69.68%            69.37%  69.37%  —27.1 

Kronen     20.26               11.86               11.86  11.86  —41.4 

Guilders     40.19               40.87%            40.75  40.87%  +    1.7 

Lire     5.1826             6.6714              6.71%  6.71%  —29.5 

Rubles     51.45               30.45               29.60  30.45  —40.8 

Swiss     francs     5.1826             5.20                 5.23%  5.20  —    0.3 

Pesetas     19.20               20.35               20.35  20.35  +    0.5 

Milreis     (Rio)     32.46               23.96               23.53  23.55  —27.1 

Pesos   (Buen.  Aires)    ....42.44              43.29              43.25  43.25  +    2.0 

The  last  column  showing  premiums  and  discounts  (or  per- 
centage deviations  of  the  rates  from  "par")  is  introduced 
because  of  the  extraordinary  dislocations  of  the  exchanges 
occasioned  by  the  European  conflict.  The  "par,"  or  more 
fully,  the  "mint  par,"  is  a  figure  showing  the  amount  of 
gold  money  of  one  country  that  has  the  same  quantity  of 
pure  or  fine  metal  in  it  as  the  gold  unit  of  some  other 
given  country,  the  units  of  both  countries  being  taken  as 
defined  by  law  (compare  §106).  Thus  the  first  item  sig- 
nifies that  4.8665  dollars  of  gold  coin  of  the  United  States 
contain  the  same  quantity  of  fine  gold  (113.0015  grains 
troy)  as  the  British  sovereign,  or  one-pound  coin.  When 
stated  as  equations,  the  pars  listed  in  the  foregoing  table 
become  the  following.  The  equality  asserted  is  simply  one 
of  fine  gold  contents  as  defined  by  law. 

U.  S.  dollars        4.8665  =  1  sovereign,  or  one-pound  coin 

of  England. 
French   francs     5.1826  =  1  U.  S.  dollar. 

U.  S.  dollars  95.28     =  400  marks  of  Germany. 

U.  S.  dollars  20.26      =  100  kronen  of  Austria. 

U.  S.  dollars  40.19     =  100  guilders  of  Holland. 
Italian  lire  5.1826  =  1  U.  S.  dollar. 


78  FOREIGN  EXCHANGE 

U.  S.  dollars      31.45     =  100  rubles  of  Russia. 

Swiss  francs        5.1826  —  1  U.  S.  dollar. 

U.  S.  dollars      19.20     =  100  pesetas  of  Spain. 

The  last  two  items,  for  Brazil  and  Argentina,  are  omitted 
because,  although  given  by  the  reporter,  they  are  hardly 
significant  mint  pars. 

§  24.  Comment  and  explanations. — The  tables  of  rates 
suggest  the  existence  of  a  single  and  unified  market  for 
exchange,  such  as  is  found  for  securities  and  staple  com- 
modities in  the  stock  and  produce  exchanges  (i.e.,  exchange- 
buildings).  Foreign  exchange  is  not,  however,  bought  and 
sold  at  any  single  meeting  place.  Dealings  in  it  never- 
theless unite  in  a  virtually  single  market.  The  test  of 
such  a  market  is  presumably  the  existence  of  a  single  price 
for  a  given  grade  or  kind  of  article  at  any  moment  of 
time.  In  periods  of  unusual  activity,  the  great  securities 
and  produce  markets  split  apart  a  little  according  to  this 
test,  but  they  tend  to  coalesce  and  usually  are  single.  At 
any  instant  the  prices  for  a  given  kind  of  exchange  in 
different  parts  of  a  money  capital  like  New7  York  will  be 
so  close  together  that  there  is  a  practically  unified  market. 
Primarily  on  account  of  the  telephone,  buyers  and  sellers 
of  bills  are  in  about  as  intimate  contact  and  competition  as 
if  they  stood  in  a  group  upon  a  single  floor.  The  activities 
of  a  special  class  of  exchange  brokers,  who  move  about 
among  dealers  that  have  fixed  places  of  business,  also  con- 
tributes to  the  unification  of  the  market.  These  brokers 
make  it  a  practice  at  intervals  during  the  day  to  leave 
slips  with  the  larger  dealers,  which  give  the  momentarily 
prevailing  rates  as  they  ascertain  them  in  their  comings  and 
goings. 

Because  rates  are  so  nearly  uniform  with  the  different 
dealers,  newspapers  gather  the  data  for  their  market  re- 
ports from  any  one  of  the  leading  exchange  houses  or  from 


THE  RATES  OF  EXCHANGE  79 

some  exchange  broker.  Examination  shows  that  different 
papers  give  slightly  different  quotations  for  the  same  classes 
of  exchange  on  the  same  days.  The  reader  will  observe  that 
in  our  specimen  reports  many  rates  are  given  as  a  couple 
connected  by  the  sign  "@."  Thus  demand  sterling 
opened  at  "4.8715  @  4.8720."  This  signifies  bid  4.8715 
and  asked  4.8720.  Sales  may  fail  to  take  place  for  some 
time  after  the  opening.  But  when  they  do  occur,  after  mail 
has  been  opened  and  news  considered,  they  are  nearly  cer- 
tain to  take  place  at  either  the  bid  or  the  asked  figure,  and 
the  reporter  has  become  accustomed  to  give  these  as  the 
record  of  the  market's  opening.  The  closing  is  often  reg- 
istered in  a  similar  pair  of  figures.  We  should  note  that 
4.8715  and  4.8720  are  but  V20  of  l<j-  per  £  apart.  Thus  the 
gap  between  them  is  only  about  Moo  of  1%  of  either  one  of 
these  figures  (.0005  is  a  little  over  Moo  of  1%  of  4.8715). 

A  few  of  the  expressions  appearing  in  the  market  reports 
given  in  the  preceding  section,  call  for  comment.  The  sec- 
ond report  opens  with  the  statement  that  discounts  in  Lon- 
don "were  well  maintained  during  the  week,  yet  sterling 
here  closed  lower  than  it  was  quoted  a  week  ago."  This 
means  that  the  various  discount  rates  for  different  sorts  of 
commercial  and  banking  paper,  ruling  in  the  London  money 
market,  sustained  themselves  during  the  week  at  the  rela- 
tively high  levels  at  which  they  started.  These  several 
rates  are  intimately  related  and  move  closely  together  as 
a  group.  The  height  of  these  rates,  or  as  we  often  say, 
the  height  of  the  London  discount  rate,  helps  determine 
what  the  position  of  the  New  York  rates  of  exchange  on 
London  shall  be.  This  is  true  not  only  of  the  rates  for  long 
sterling,  but  also  of  the  sight  and  cable  rates.  A  high  dis- 
count rate  in  London  tends  to  make  New  York's  sight  and 
cable  rates  on  London  keep  high.  Hence  the  decline  of 
sight  sterling  during  the  week  covered  by  the  report,  being 
to  a  degree  contrary  to  expectation,  is  a  cause  for  com- 


80  FOREIGN  EXCHANGE 

merit  by  the  foreign  exchange  writer.  The  rate  for  sight 
sterling  declined  in  spite  of  the  tendency  of  the  "well  main- 
tained" London  discount  rate  to  hold  it  up. 

Referring  to  the  report  first  reproduced,  it  may  be  said 
the  terms  steady,  firm,  quiet,  and  the  like,  characterize  the 
general  tendency  shown  by  rates  and  have  the  same  self- 
evident  meanings  here  as  in  other  types  of  market  report. 
Up  or  off  so  many  points  compare  the  rates  of  this  day  or 
week  with  those  of  the  last  preceding  day  or  week,  or  the 
closing  rates  with  the  opening  rates  of  the  same  day.  What 
is  meant  by  a  "point"  can  be  told  only  by  context.  A 
point  in  New  York  sterling  rates  now  generally  signifies 
Moo  of  1^,  so  that  an  ascent  from  4.8610  to  4.8620  would  be 
called  a  "10  point"  rise. 

When  the  term  check  or  cheque  is  used  in  connection 
with  foreign  exchange,  it  is  simply  a  synonym  for  a  banker's 
sight  draft  on  another  banker.  Continentals  is  a  general 
term  covering  bills  of  exchange  drawn  on  other  countries 
of  Europe  than  the  British  Isles.  The  chief  continentals 
have  been,  for  us,  bills  on  France,  Germany,  and  Holland. 

The  short  interest  absorbs  bills  (first  report)  is  a  state- 
ment indicating  the  fact  that  speculation  takes  place  in 
foreign  exchange.  Since  the  rates  fluctuate  with  the  pas- 
sage of  time,  and  since  these  fluctuations  are  governed  by 
factors  which  can  be  forecasted  in  part  by  those  who  study 
them,  there  is  nearly  always  some  systematic  speculation 
going  on  in  exchange.14  A  speculator's  profit  is  made  out 
of  a  future  rise  in  the  rates  by  going  "long"  of  exchange, 
out  of  a  future  fall  by  going  "short."  There  are  various 
ways  in  which  the  operator  can  put  himself  long  or  short 
of  the  market.  When  he  is  short  he  will  need  some  time 
to  buy  in  exchange  "to  cover."  That  is,  he  will  need  to 
buy  in  an  amount  of  exchange  to  meet  his  commitments. 

14  Chapter  XIII  deals  with  speculation  in  exchange. 


THE  RATES  OF  EXCHANGE  81 

He  hopes  to  buy  it  in  cheap  enough  to  reap  a  profit.  On 
the  occasion  which  the  reporter  had  under  review,  he  be- 
lieved he  had  detected  the  fact  that  dealers  then  short  were 
quietly  buying  in  bills  to  cover.  Whether  they  cover  at  a 
profit  or  loss  in  this  particular  instance,  does  not  appear. 
The  fact  that  they  are  covering  quietly  would  indicate 
at  least  that  the  shorts  are  not  facing  any  great  losses  and 
are  not  in  a  panic. 

Exchange  on  London  in  Paris  and  Berlin,  or  ' '  Paris  and 
Berlin  sterling"  is  frequently  quoted  in  the  New  York  re- 
ports. This  news  is  included  because  of  its  bearing  upon 
the  probable  future  course  of  sterling  in  New  York  itself. 
The  rates  for  sterling  exchange  in  Paris  and  Berlin  have 
quite  a  close  connection  with  the  rate  for  sterling  in  New 
York.  For  instance,  a  rise  of  sterling  in  Paris  tends  to 
produce  a  rise  in  New  York.  This  is  because  of  the  exist- 
ence of  the  line  of  operations  known  as  arbitrage  in  ex- 
change.15 

Rio  exchange  on  London  quoted  at  15%2,  is  sterling  ex- 
change in  Rio  Janeiro,  Brazil,  quoted  in  the  "indirect" 
manner,  as  the  number  of  British  pence  allowed  for  one 
Brazilian  (inconvertible  paper)  unit,  or  "milreis."  This 
rate  is  of  interest  to  Americans  who  have  either  to  make 
payments  to  or  receive  them  from  Rio.  Remittances  be- 
tween Rio  Janeiro  and  New  York  in  either  direction  were 
before  the  war  very  likely  to  be  made  either  directly  in 
sterling  exchange,  or  else  in  ways  which  indirectly  involved 
sterling. 

We  have  given  no  example  of  the  more  lengthy  foreign 
exchange  reviews  which  appear  from  time  to  time  in  the 
daily  and  weekly  financial  papers.  These  reviews  are  char- 
acterized by  a  remarkable  breadth  of  view  over  commercial 
and  political  conditions.     Great  events  which  influence  the 

10  See  Chapter  XIV. 


82  FOREIGN  EXCHANGE 

chances  of  war,  or  which  touch  the  finances  of  nations,  and 
movements  in  the  stock  markets  of  the  different  countries, 
as  well  as  the  immediate  course  of  commerce  in  merchan- 
dise, all  are  subject  to  the  scrutiny  and  analysis  of  the 
foreign  exchange  writer,  because  any  or  all  of  these  things 
may  profoundly  affect  the  course  of  exchange.  "War  will, 
for  instance,  produce  perturbations  in  the  international 
movement  of  securities  and  merchandise  and  cause  signifi- 
cant alterations  in  national  currency  conditions,  and  will 
therefore  create  important  disturbances  in  exchange  supply 
and  demand  and  rates. 

Posted  or  nominal  rates  are  those  asked  by  bankers  for 
checks  and  letters  of  credit  sold  in  small  lots.  "Actual" 
rates  are  those  at  which  purchases  and  sales  take  place  be- 
tween bankers  and  dealers  themselves,  or  at  which  the  larger 
purchases  of  merchants  from  bankers  take  place.  (But  a 
"nominal"  rate  sometimes  means  one  quoted  for  a  market 
so  very  inactive  as  to  be  practically  one  in  name  only.) 
The  rates  given  in  our  specimen  reports  are  actual  unless 
otherwise  indicated.  Posted  rates  range,  in  the  case  of 
sterling,  from  %  cent  to  B£  cent  per  pound  higher  than 
actual  rates,  and  fluctuate  much  less.  The  following  is  an 
example  of  a  table  of  posted  rates,  taken  from  the  Com- 
mercial and  Financial  Chronicle. 

Posted  Rates 

The  following  shows  daily  posted  rates  for  sterling  exchange 
by  some  of  the  leading  drawers: 

Tues-    Wednes-    Thurs- 
Friday    Monday       day  day  day      Friday 

Nov.  26    Nov.  29    Nov.  30      Dec.  1      Dec.  2     Dec.  3 


Brown 
Bros.    &   Co. 

60  days 
sight 

4.84% 
4.88% 

4.84% 

4.88% 

4.84% 
4.88% 

4.S4% 
4.88% 

4.84% 
4.88% 

4.84% 
4.88% 

Kidder 
Peabody    &    Co. 

60  days 
sight 

4.84% 
4.88 

4.84% 
4.88% 

4.84% 
4.88% 

4.84% 
4.88% 

4.84% 
4.88% 

4.84% 
4.88% 

Bank    British 
North  America 

60  days 
sight 

4.84% 

4.88V2 

4.84% 
4.88V2 

4.84% 
4.88% 

4.84% 
4.88% 

4.84% 
4.88% 

4.84% 
4.88% 

THE  RATES  OF  EXCHANGE 


83 


Tues. 

Wednes- 

Thurs- 

Friday 

Monday 

day 

day 

day 

Friday 

Nov.  26 

Nov.  29 

Nov.  30 

Dec.  1 

Dec.  2 

Dec.  3 

Bank   of 

Montreal 

60  days 

4.84% 

4.84% 

4.84% 

4.84% 

4.84% 

4.84% 

sight 

4.88 

4.88 

4.88 

4.88 

4.88 

4 

88 

Canadian   Bank 

of    Commerce 

60  days 

4.84 

4.84% 

4.84% 

4.84% 

4.84% 

4 

84% 

sight 

4.88% 

4.88% 

4.88% 

4.88% 

4.88% 

4 

88% 

Heidelbach    Ickel- 

heimer    &    Co. 

60  days 

4.84 

4.84% 

4.84% 

4.84% 

4.84% 

4 

84% 

sight 

4.88% 

4.88% 

4.88% 

4.88% 

4.88% 

4 

88% 

Lazard 

Freres 

60  days 

4.84% 

4.84 

4.84 

4.84 

4.84 

4 

84 

sight 

4.88 

4.88 

4.88 

4.88 

4.88 

4 

88 

Merchants'    Bank 

of  Canada 

60  days 

4.85 

4.84% 

4.84% 

4.84% 

4.84% 

4 

84% 

sight 

4.88 

4.88 

4.88 

4.88 

4.88 

4 

88 

The  table  just  beneath  is  copied  from  a  card  issued  by 
a  certain  bank  of  Chicago,  under  normal  or  pre-war  con- 
ditions. 

Foreign  Department 

Rates  for  drafts  until  further  notice: 


Checks 

Checks  for 

Under  $100  $100  to  $10,000 

Pounds  £  on  England 

$4.8725 

$4.87 

Pounds  £  on  Scotland  and  Ireland 

4.875 

4.8725 

Pounds  £  on  Greece 

4.875 

4.8725 

Pounds  £  on  Australasia 

4.875 

4.8725 

Pounds  £  on  Turkey  and  Egypt 

4.885 

4.88 

Pounds  £  on  South  Africa 

4.90 

4.8875 

Francs  on  France 

.1935 

.1932 

Francs  on  Belgium 

.1925 

.1922 

Francs  on  Switzerland 

.1935 

.1932 

Francs  on  Turkey  and  Egypt 

.1945 

.1940 

Marks  on  Germany 

.2380 

.2377 

Guilders  on  Holland 

.4035 

.4032 

Kronen  on  Austria 

.2028 

.2025 

Lire  on  Italy   (checks) 

.1925 

.1922 

Lire  on  Italy  (post  remit.) 

.1930 

.1925 

Kroner  on  Scandinavia 

.2683 

.2680 

Pesetas  on  Spain 

.1825 

.1820 

Finmark  on  Finland 

.1950 

.1940 

Roubles  on  Russia  (checks) 

.5155 

.5150 

.5225 

.52 

.5010 

.50 

.4650 

.4640 

.50 

.4995 

Mo% 

prem. 

%6% 

pre  in. 

%% 

prem. 

y2% 

prem. 

SI  FOREIGN  EXCHANGE 

Roubles  on  Russia   (post  remit) 

Yen  on  Japan 

$  local  currency  on  Hong  Kong 

Pesos  on  Philippine  Islands 

U.  S.  Dollars  on  Hawaii 

U.  S.  Dollars  on  Cuba 

U.  S.  Dollars  on  Porto  Rico 

U.  S.  Dollars  on  Panama 

We  will  make  special  rates  on  drafts  costing  $10,000  or  more. 

A  glance  at  the  table  on  page  82  shows  that  the  posted 
rates  of  leading  New  York  houses  are  for  the  most  part 
the  same,  though  some  houses  may  give  quotations  varying 
by  as  much  as  Vi§  from  those  of  the  majority.  No  such 
differences  can  exist  between  the  actual  rates  at  which 
different  houses  are  doing  business.  In  the  table  imme- 
diately above  the  rates  for  drafts  payable  in  American 
dollars  in  Hawaii,  Cuba,  Porto  Rico,  or  Panama,  are  quoted 
according  to  the  ordinary  method  followed  in  domestic  ex- 
change, except  that  the  premium  is  expressed  in  fractions 
of  1%  instead  of  in  cents  per  $1,000.  A  draft  for  $1,000 
on  Cuba  would  at  the  rate  quoted,  cost  $1,000,  plus  Mo  of 
1%  of  $1,000  (or  $1.87).  All  the  other  rates  are  expressed 
simply  as  the  amount  of  American  money  charged  for  one 
unit  of  foreign  money.  It  wrill  be  observed  that  the  drafts 
offered  for  sale  on  certain  of  the  countries  on  the  list,  are 
not  drawn  in  terms  of  the  national  moneys  of  those  coun- 
tries. Thus  drafts  on  Greece  are  in  pounds  sterling,  and 
drafts  on  Turkey  are  offered  both  in  pounds  sterling  and 
in  francs. 

§  25.  The  classes  of  exchange  quoted. — A  classification  of 
exchange  may  be  founded  upon  any  one  of  three  bases, 
(1)  length  of  life,  or  the  time  to  elapse  until  payment  is 
due,  (2)  domicile,  or  the  place  where  the  exchange  is  pay- 
able, and  (3)  security.  Distinguished  according  to  length 
of  life,  the  more  common  classes  are  (a)  telegraphic  trans- 


THE  RATES  OF  EXCHANGE  85 

fers  or  "cables,"  (b)  sight  or  demand  bills,  (c)  sixty 
days'  sight  bills,  and  (d)  ninety  days'  sight  bills.  By  a 
sixty  days'  sight  bill  is  meant,  of  course,  one  payable  sixty 
days  after  the  date  of  sight  by  drawee  or  date  of  acceptance. 
Less  common  types  are  drafts  payable  at  3,  7,  10,  and  30 
days,  and  four  and  six  months  after  sight,  and  drafts 
payable  at  various  designated  periods  after  date  instead  of 
after  sight.  Telegraphic  transfers  will  be  discussed  in  §  26. 
If  the  law  of  the  place  where  time  bills  are  payable,  allows 
days  of  grace,  these  days  must  be  added  to  the  period  speci- 
fied in  the  bill,  to  ascertain  the  legally  effective  date  of  ma- 
turity. Days  of  grace  may  be  waived  and  a  bill  may  be  so 
written  as  to  deny  them,  but  commonly  nothing  is  said  about 
them  and  therefore  they  are  counted. 

Classification  according  to  domicile  is  too  simple  a  mat- 
ter to  call  for  extended  comment.  Distinguished  accord- 
ing to  domicile,  we  have  in  our  market  English,  French, 
German,  Italian,  and  Spanish  exchange,  and  so  forth. 
Sometimes  exchange  drawn  on  a  given  country  is  called 
by  the  name  of  the  money  unit  of  that  country.  Thus 
when  a  person  means  that  exchange  on  Germany  has  become 
cheaper,  he  may  say  that  "marks  have  fallen." 

The  third  basis  of  classification  is  security.  In  this  con- 
nection we  mean  by  the  term  security  that  which  assures 
or  helps  assure  the  holder  of  commercial  paper  or  of  promis- 
sory obligations  in  general,  that  he  will  be  able  to  collect 
what  is  due  him.  In  this  sense,  security  falls  into  two 
classes,  (1)  personal  and  (2)  collateral  security.  Personal 
security  is  the  liability  to  pay  of  any  person  10  who  is  bound. 
The  obligor's  liability  is  the  holder's  security.     Collateral 

i«  A  "natural"  person  is  an  ordinary  individual  and  a  "legal"  or 
"artificial"  person  is  a  corporation,  private  <>r  public.  Personal 
security  includes  the  liability  to  pay  of  both  natural  and  artificial 
persons.  A  corporation  as  such  may  hind  itself  to  make  payment 
of  moneys  and  this  is  legally  quite  a  distinct  thing  from  all  the 
individuals  composing  the  association    (known   as  the  corporation) 


86  FOREIGN  EXCHANGE 

security  consists  in  articles  of  value  (often  promissory 
obligations  such  as  bonds,  notes,  or  acceptances,  or  again 
corporation  shares,  or  warehouse  receipts  and  bills  of  lad- 
ing which  entitle  the  holder  to  receive  designated  lots  of 
merchandise)  which  are  pledged  to  the  holder  of  an  obliga- 
tion or  are  otherwise  legally  placed  at  his  disposal  so  as 
to  enable  him  t.n  realize  upon  their  value  in  case  the  per- 
sons bound  on  the  obligation  fail  to  make  payment,  or  pay- 
ments when  due.  This  security  is  " collateral"  in  the 
sense  .that  it  exists  along  side  of  and  in  addition  to  the 
primar}-  personal  security. 

There  are  three  main  classes  of  exchange  distinguished 
according  to  personal  security.     These  are 

(1)  Bankers'  drafts  on  bankers,  including  telegraphic 

transfers.17 

(2)  Merchants'  drafts  on  bankers. 

(3)  Merchants'  drafts  on  merchants. 

The  possible  class  of  bankers '  drafts  on  merchants  does  not 
figure  in  practical  life.  Full  explanation  of  the  origin  and 
manner  of  handling  these  several  types  of  exchange  be- 
longs to  subsequent  chapters.  Exchange  of  the  first  class 
has  a  bank  as  drawer  18  and  a  bank  as  drawee,  and  in  the 
case  of  time  bills  a  bank  as  acceptor.  Judged  from  the 
standpoint  of  personal  security,  then,  this  is  in  general 
the  highest  class  of  exchange.  (Compare  §  12  on  the  lia- 
bility of  parties.)  Exchange  of  the  second  class  mentioned 
above  (consisting  almost  always  in  long  bills)  is  drawn 
under  a  letter  of  credit  or  "against  a  bank  credit,"  and 

binding  themselves  severally  or  jointly  and  severally.  The  bank  is 
usually  a  corporation. 

it  Practically  speaking,  telegraphic  transfers  are  sold  exclusively 
by  bankers  to  be  payable  abroad  by  bankers. 

is  We  may  perhaps  speak  loosely  of  the  drawer  and  drawee  of  a 
telegraphic  order  to  pay  money. 


THE  RATES  OF  EXCHANGE  87 

will  after  acceptance  have  a  banker  as  principal  obligor 
and  a  merchant  with  the  liability  of  the  drawer.  After 
acceptance,  and  even  before,  it  has  virtually  the  same  credit 
rating  as  the  first  class.  (Chapter  VII  treats  of  the  bank 
credit  and  the  letter  of  credit.)  The  third  class  of  ex- 
change is  inferior  in  general  in  point  of  personal  security, 
since  it  has  merchants  only  as  parties  liable. 

Personal  security  is  much  more  important  than  collateral 
security,  especially  perhaps  in  connection  with  exchange, 
though  one  who  is  a  novice  in  the  subject  is  unlikely  to 
realize  this  fact.  Distinguished  with  respect  to  collateral 
security,  exchange  divides  itself  first  of  all  into  two  main 
and  obvious  classes,  (1)  exchange  without,  and  (2)  ex- 
change with  collateral  security.  Exchange  drawn  by  bank- 
ing houses  proper  rarely  if  ever  has  collateral.19  That 
drawn  by  traders  in  goods  and  securities  usually  has  colla- 
teral. 

Every  distinct  class  and  subclass  of  exchange  may  take 
a  distinct  rate  of  exchange.  But  newspapers  publishing 
market  tables  do  not  endeavor  to  give  every  one  of  these 
distinct  rates.  They  are  usually  satisfied  to  give  one  main 
table  which  covers  exchange  drawn  by  bankers  on  bankers. 
The  principal  tables  reproduced  in  §  23  illustrate  this.  In 
the  first  two  of  these,  bankers'  exchange  is  divided  into  sub- 
classes according  to  length  of  life  on  the  one  hand  and 
domicile  on  the  other.  With  four  classes  according  to 
length  of  life  and  four  according  to  domicile,  this  gives 
sixteen  separate  rate  quotations,  as  the  reader  may  have 
observed.  The  market  report  will  often  give  the  rates  for 
some  of  the  classes  of  bills  of  other  grades  of  security  than 
the  bankers'  drawings,  but  will  not  attempt   a  complete 

i»  Acceptance  accounts  (see  pp.  144-7)  are  presumably  more  often 
than  not,  protected  by  collateral,  but  this  is  not  collateral  security 
for  the  bill  of  exchange  itself  and  is  not  open  to  attack  by  the  holder 
of  this  instrument. 


88  FOREIGN  EXCHANGE 

tabulation  for  all  types  and  subclasses  of  these.  For  in- 
stance, in  the  report  reproduced  on  pages  75-6,  we  find  the 
following: 

Commercial  on  banks   4.8280  @  4.8290 

Documents  for  payment    4.82  @  4.82% 

Cotton  for  payment   4.83  @  4.831/4 

Grain  for  payment  4.831/4  @  4.83% 

These  are  all  classes  of  exchange,  though  the  names  given 
do  not  indicate  it  any  too  clearly  to  the  beginner.  One 
who  knows  the  subject  can  tell  what  each  item  means, 
though  we  shall  not  attempt  at  present  to  explain  how. 
All  four  classes  are  drafts  drawn  on  England  at  §ixty 
days'  sight  by  merchants.  The  first  item  refers  to  the  gen- 
eral class  of  bills  drawn  upon  English  banks  under  the 
authorit}-  of  commercial  letters  of  credit.  Documents  will 
be  attached  to  these  drafts  but  nothing  is  stated  in  the 
table  to  indicate  the  fact.  The  second  item  covers  trade 
bills,  drawn  by  exporting  merchant  upon  importing  mer- 
chant, against  shipments  of  miscellaneous  sorts  of  com- 
modities. Documents  are  attached  and  will  be  surrendered 
to  the  importer  when  he  pays  the  draft,  hence  the  phrase 
"documents  for  payment."  (See  especially  Chapter  VI 
below.)  These  drafts  cannot  be  drawn  on  banks  abroad 
because  documents  are  never  "for  payment"  when  a  bank 
is  drawee.  The  third  and  fourth  items  refer  to  special 
classes  of  bills — again  with  documents  for  payment — drawn 
against  exports  of  cotton  and  grain  respectively.  These 
are  types  of  trade  bills  of  especial  importance.  Why  they 
enjoy  such  high  rates  can  hardly  be  made  clear  at  this 
point.  To  be  explicit,  the  last  item  "grain  for  payment" 
means  drafts  drawn  at  sixty  days'  sight  by  exporters  of 
grain  upon  the  importing  merchants  with  the  shipping 
documents,  pertaining  to  the  grain,  attached  to  the  drafts 
and  deliverable  to  the  importers  against  payment  of  the 


THE  RATES  OF  EXCHANGE  89 

drafts  whether  at  the  time  of  maturity  or  prior  to  that 
time. 

Inspection  shows  that  the  longer  the  life  of  a  given  type 
of  exchange,  the  cheaper  the  rate  for  it  will  be.  Interest 
or  discount  is  of  course  the  explanation.  (The  methods  of 
calculating  the  rates  for  long  exchange  will  be  discussed  in 
Chapter  IX.)  In  the  case  of  the  rates  on  France,  cheaper 
rates  mean  higher  figures  because  the  rates  are  quoted  in  the 
reverse  or  indirect  manner  (compare  §22). 

26.  The  telegraphic  transfer  or  cable. — Orders  directing 
the  payment  of  money  abroad  which  are  transmitted  by 
telegraph  instead  of  by  the  mailing  of  a  draft,  are  known 
as  "telegraphic  transfers"  (abbreviated  "t.  t.")  and  also 
in  this  country  as  "cables."  The  cable  does  not  involve 
a  written  and  negotiable  bill,  but  it  is  still  classified  as 
exchange  because  it  occasions  the  same  transactions  and 
payments  as  a  bill.  The  purchaser  of  the  cable  designates 
the  person  abroad  to  receive  payment.  The  bank  which 
sells  the  cable  is  analogous  to  the  drawer  of  the  bill,  and 
the  bank  directed  to  make  payment  to  the  drawee.  The 
bank  which  sells  a  cable  of  the  amount  of  £10,000  for  a 
price  in  domestic  money  of  $48,750,  will  find  its  London 
balance  reduced  by  £10,000  and  its  home  office  funds  in- 
creased by  $48,750  as  a  result  of  .the  operation,  in  the  same 
way  as  if  it  had  sold  a  bill  except  that  in  the  case  of  the 
cable  the  depletion  of  the  foreign  balance  will  take  place 
earlier,  often  in  fact  on  the  same  business  day  with  the 
sale. 

In  communicating  telegraphic  orders  banks  use  individ- 
ual secret  codes.  These  codes  serve  the  twofold  object  of 
reducing  cable  charges  and  of  guarding  against  the  trans- 
mission of  fraudulent  orders  by  unauthorized  persons.  The 
genuineness  of  a  bill  of  exchange  is  judged  chiefly  by  the 
signature,  but,  in  the  absence  of  a  written  instrument,  the 
genuineness  of  the  cable  is  judged  in  part  by  secret  si^ns 


90  FOKKMiX   EXCHANGE 

in  the  code  dispatch,  sut'li  as  tost  words,  constituting  the 
lirst  or  last  words  of  the  message,  or  other  devices.  The 
purchaser  of  this  form  of  exchange  takes  a  receipt  for  his 
money,  which  lecites  the  relevant  facts  of  the  order,  and 
this  lie  holds  as  evidence  of  his  claims  for  reimbursement 
in  the  event  of  the  failure  of  the  required  delivery  of 
English  money  to  his  foreign  payee.  The  selling  bank 
and  its  correspondent  assume  no  liability  for  mistakes  or 
delay  in  the  transmission  of  messages  by  the  cable  com- 
panies. 

The  fact  that  cables  sell  for  a  higher  rate  than  demand 
drafts  is  due  wholly  to  the  priority  of  their  payment  abroad, 
and  has  nothing  to  do  with  the  telegraph  charges.  The 
latter  are  as  great  for  small  as  for  large  sums  and  are  paid 
for  separately.  In  the  case  of  relatively  small  orders,  say 
for  less  than  £5,000,  the  purchaser  pays  the  cable  charges ; 
for  larger  orders  the  selling  bank  is  apt  to  assume  these 
charges.20 

§  27.  Sterling  rates. — For  historical  reasons  the  money  of 
England  is  called  sterling.  Likewise  exchange  drawn  on 
and  payable  in  England  is  called  sterling  exchange,  or 
again  merely  sterling.  The  British  monetary  unit,  the 
pound  sterling,  consists  of  123171/^23  (or  123.27447)  grains 
troy  of  gold  W12  fine,  with  a  pure  or  fine  contents  of  113^23 
grains.  The  one-pound  money  piece  of  gold  is  called  the 
sovereign.  The  mint  par  between  the  United  States  and 
Great  Britain  is  4.866564.  That  is  to  say,  the  British  unit 
as  defined  by  law  contains  the  same  quantity  of  fine  gold 
as  4.8665  -f-  United  States  gold  dollars  as  they  are  defined 
by  law.21     The  English  money  notation  is  as  follows : 

1  pound  =  20  shillings  =  240  pence  =  960  farthings. 

1  shilling  <=    12  pence  =   48  farthings. 

1  penny  =     4  farthings. 

20  Margraff,  "International  Exchange,"  p.  51. 

2i  For  more  extended  comment  on  the  mint  par  see  Chapter  XV. 


THE  RATES  OF  EXCHANGE  91 

The  farthing  is  of  little  practical  consequence.  A  sum  of 
English  money  is  commonly  written  in  figures  in  the  follow- 
ing manner:  £3.  17s.  9d.  or  £3.  17/9  (namely,  three  pounds, 
seventeen  shillings,  and  nine  pence — which  is,  incidentally, 
the  Bank  of  England's  minimum  buying  price  for  gold 
bullion  per  ounce  n/i2  fine).  £,  s,  and  d,  are  abbreviations 
for  the  Latin  words,  libra,  solidus,  and  denarius.  Shillings 
are  also  abbreviated  as  "sh."  For  the  purposes  of  com- 
putation it  is  often  desirable  to  reduce  shillings  and  pence 
to  decimal  fractions  of  pounds.  "We  shall  attend  to  this 
simple  arithmetical  problem  in  a  later  section. 

In  our  market,  sterling  rates  are  at  once  the  most  im- 
portant and  the  simplest  in  form.  It  has  already  been 
made  clear  that  these  rates  are  expressed  as  the  number  of 
dollars  paj-able  for  one  pound  of  exchange.  A  word  is  in 
order  regarding  the  standard  scale  of  intervals  along  which 
they  rise  and  fall.  There  are  really  two  customary  scales. 
The  first  and  older  is  the  scale  by  eighths  of  a  cent  per 
pound.  Beginning  say  with  4.86  the  rates  next  in  order 
above  according  to  this  scale  would  be  4.86Ms,  4.86:,4,  4.86%, 
and  so  on.  Under  more  recent  practice,  especialh'  in  New 
York,  rates  are  made  to  rise  and  fall  by  intervals  of  ^ioo 
of  a  cent,  so  that  the  rates  in  order  above  4.86  would  be 
4.8605,  4.8610,  4.8615,  4.8620,  and  so  forward.  With  this 
scale,  prices  may  be  shaded  to  a  somewhat  finer  degree  than 
under  the  earlier  one.  On  occasion  the  two  scales  will  be 
found  combined.  If,  where  the  system  of  eighths  is  em- 
ployed, exchange  rises  from  4.86V8  to  4.86H,  the  reporter  is 
apt  to  speak  of  an  advance  of  \b  of  a  "point."  A  point 
must  therefore  in  this  case  mean  1^  per  pound  sterling. 
On  the  other  hand,  a  rise  of  quotations  from  4.8605  to 
4.8610  is  usually  called  an  advance  of  5  points,  so  that  in 
this  instance  a  point  means  only  Moo  of  a  cent.  In  the 
.sterling  market,  dealers  have  managed  to  shade  prices  to  a 
sufficiently  fine  degree  by  the  very  simple  and  proper  method 


92  FOREICX   EXCHANGE 

of  extending  the  number  of  figures  in  the  decimal  part  of 
the  rate,  ami  quotations  are  not  hampered  by  the  peculiar 
supplementary  fractions  found  in  the  French  and  German 
rates  as  given  in  New  York. 

Under  ordinary  conditions  the  rates  for  bankers'  sight 
sterling  fluctuate  between  approximately  4.88  and  4.84  as 
upper  and  lower  limits.  Ascent  above  the  upper  limit  is 
checked  by  the  indefinite  supply  of  bills  which  will  be 
forthcoming  at  this  point  by  reason  of  exports  of  gold,  and 
decline  below  the  lower  is  checked  by  the  indefinite  demand 
for  bills  which  will  arise  because  of  imports  of  gold.  These 
limits,  called  the  "gold  points,"  are  not  invariable  even 
under  ordinary  conditions,  but  the  range  of  their  move- 
ment is  a  narrow  one.  The}'  depend  upon  both  countries 
being  on  the  gold  standard  in  point  of  practical  fact  as 
well  as  in  legal  theory.22  It  goes  without  saying  that  the 
present  war-time  conditions  are  not  ordinary.  In  the  first 
week  of  August  1914  there  were  some  sales  of  sterling 
cables  in  New  York  at  the  rate  of  $7.00  per  pound !  Again 
on  September  1,  1915,  New  York  quotations  for  cables 
touched  $4.50  per  pound,  during  an  exchange  flurry! 

§  28.  The  rates  on  France. — The  monetary  unit  of  France, 
called  the  franc,  is  defined  by  French  law  which  declares 
that  3,100  francs  shall  be  coined  from  1  kilogram  of  gold 
%o  fine.  No  gold  coin  so  small  as  the  franc  is  struck,  but 
the  franc  as  a  legal  unit  consists  of  .32258  grams  of  standard 
gold  (%o  fine)  or  .290322  grams  fine.  The  franc  as  a  unit 
of  account  is  divided  into  100  centimes. 

In  the  table  of  exchange  rates  on  page  75,  bankers'  de- 
mand francs  are  quoted  at  5.171/!  This  figure  signifies 
that  5  and  17%  hundredths  francs,  or  5  francs  and 
17%  centimes,  face  value  of  draft  in  French  money, 
may  be  bought  for  $1  of  American  money.     This  means 

22  Gold  shipments  are  considered  in  Chapter  XX  and  the  general 
theory  of  exchange  supply  and  demand  and  the  rates,  in  Chapter  XXI. 


THE  RATES  OF  EXCHANGE  93 

that  New  York  quotes  francs  according  to  the  "in- 
direct" method,  as  we  explained  this  term  in  §  22.  If  one 
pays  at  the  rate  of  $1  for  5.17%  francs,  each  franc  costs 
19.32  -f-  cents,  and  there  is  no  compelling  reason  why  the 
rate  should  not  be  quoted  as  cents  per  franc  (or  dollars 
per  hundred  francs),  as  it  is  in  the  smaller  dealings  in  the 
interior  cities  of  the  United  States.  But  in  New  York  the 
dealers  have  chosen  to  quote  bills  on  France  according  to 
the  indirect  method.  The  price  of  a  sight  draft  on  Paris 
for  say  4191.75  francs  at  the  rate  of  5.17%  is  to  be  ascer- 
tained by  dividing  4191.75  by  5.175.  For  every  5.175 
francs  face  value  of  the  draft  the  purchaser  must  pay  $1, 
and  the  draft  will  cost  as  many  dollars  as  5.175  is  contained 
times  in  4191.75,  namely  $810. 

The  ordinary  scale  along  which  the  French  rate  rises  and 
falls  has  intervals  of  %  of  a  centime.  Going  in  one  direc- 
tion from  5.17%  the  next  rates  would  be  in  order 

'5.17% 
5.18% 

5.18% 
5.19% 
5.20  etc. 

5.18%  is  a  cheaper  rate  than  5.17%,  since  under  it  the  buyer 
receives  more  French  money  per  dollar,  or  pays  a  less  num- 
ber of  dollars  for  a  given  sum  of  French  money.  Though 
the  scale  of  intervals  of  %  of  a  centime  is  customary,  it  is 
not  rigidly  followed.  Thus  in  the  table  on  page  75,  cables 
are  quoted  at  5.17%  plus  %e.  Disregarding  the  "plus  He" 
for  the  present,  5.17!4  is  a  figure  lying  outside  of  the  ordi- 
nary series  which  jumps  from  5.16%  to  5.17%.  The  expla- 
nation given  for  the  customary  intervals,  is  lliat  r's  of  a 
centime  is  very  nearly  equivalent  to  Vs  of  a  cent,  American 
money.  The  latter  was  for  a  long  time  the  Btandard  in- 
terval in  sterling  quotations,  and  so  a  closely  corresponding 


H  FOREIGN  EXCHANGE 

interval  was  adopted  in  the  quotations  of  rates  on  France.23 
The  supplemental  fractions  in  the  French  rates. — Com- 
petition has  reached  the  point  which  makes  it  necessary  for 
dealers  to  shade  prices  to  a  finer  degree  than  is  possible 
with  the  interval  of  %  of  a  centime.  The  device  employed 
to  effect  this  object  is  the  addition  to  the  main  rate  of  the 
supplemental  fractions,  plus  or  minus  Mg,  %2  or  %4,  etc. 
Thus  (table  on  page  75)  we  find  the  rate  for  bankers'  60 
day  bills  quoted  as  "5.19%  less  Ym."  Again  (table  on  page 
76),  the  Commercial  and  Financial  Chronicle  gives  the  high 
rate  for  long  francs  as  "5.19%  h  @  5.19%  a,"  and  explains 
in  a  note  that  a  signifies  "less  Vis  of  1%,"  and  h  "less 
%2  of  1%."  "5.19%  less  %«  of  1%"  is  of  course  near  the 
rate  of  5.19%  flat.  Adjacent  to  5.19%  flat  on  either  hand 
in  the  conventional  scale  are  5.18%  and  5.20.  But  5.19% 
less  Yic  does  not  lie  between  5.19%  and  5.18%,  but  between 
5.19%  and  5.20! 

With  regard,  now,  to  the  precise  meaning  of  such  supple- 
mental fractions  as  "plus  Ms"  or  "less  Vi6,"  we  may  begin 
by  explaining  what  they  do  not  signify.  They  do  not  sig- 
nify simply  plus  or  minus  \i&  centime.  If  this  were  their 
meaning,  the  rate  5.19%  less  Vie  would  merely  stand  for 
5.19%*  and  might  be  so  written.  (That  is,  5.19%  equals 
5.19%r,  and  this  less  Yiv  would  be  5.19%6.)  The  fraction 
"less  He"  means  "less  Vik  of  1%  of  the  price  of  the  bill," 
and  signifies  that  the  purchaser  is  to  pay  for  the  bill  at 
the  rate  of  $1  for  each  5.19%  francs  and  is  then  to  receive 
a  rebate  of  He  of  1%  of  the  total  price  of  the  bill  as  first 
figured  at  5.19%  flat.  The  fraction  "less  ^6"  means  a 
drawback  of  Ho  of  1%  to  the  purchaser,  while  "plus  %6" 
means  that  he  must  add  this  amount  to  the  price.  To 
illustrate,  suppose  a  purchaser  desires  to  bu}r  a  bill  for 

207,750  francs  @  5.19%  less  %«. 
23  H.  K.  Brooks,  "Foreign  Exchange  Text-Books,"  pp.  113-14. 


THE  RATES  OF  EXCHANGE  95 

The  price  of  this  bill  at  the  flat  rate  of  5.19%  would  be 
found  as  follows: 

5.19%  =  5.19375 

If  5.19375  francs  cost  $1,  207,750  francs  will  cost  as  many 

dollars  as  5.19375  is  contained  times  in  207,750. 
5.19375)  207,750.00000   (40,000 


207,750.0 

or  $40,000. 

The  supplemental  fraction  indicates  that  the  purchaser  is 
entitled  to  a  reduction  or  rebate  of  Vie  of  1%  of  $40,000. 
1%  of  $40,000  is  $400,  and  Vie  of  this  is  $25.  Therefore, 
since  $40,000  —  $25  =  $39,975, 

207,750  francs  @  5.19%  less  Via  will  cost  $39,975. 

If  the  rate  were  5.19%  plus  Viq,  the  price  of  the  bill  would 
be  $40,025.  The  use  of  the  technical  supplementary  frac- 
tions, taken  in  connection  with  the  indirect  method  of 
quoting  the  main  part  of  the  French  rate,  makes  the  whole 
figure  a  puzzling  one  to  the  novice.24 

§  29.  The  rates  on  Germany  and  other  countries. — The 
money  unit  of  Germany  is  the  mark,  consisting  in  .398274 

24  To  look  a  little  further  into  the  curiosities  of  this  notation, 
we  may  explain  that  to  place  "minus  Vio"  after  a  rate  brings  that 
rate  a  little  more  than  half  way  towards  the  next  cheaper  main 
rate.  Thus  5.10%  less  Via  is  a  little  closer  to  5.20  than  it  is  to 
5.19%.  On  the  other  hand  ~>.20  plus  lAo  is  a  little  closer  to  5.19% 
than  to  5.20!  But  the  two  rates,  ~).l!)':s  lass  Vie  and  5.20  plus  Via 
are  almost  identical.  The  interval  of  %  centime  between  the  main 
rates  is  an  interval  of  almost  exactly  Vi  of  1%.  Consequently  an 
addition  or  subtraction  of  Vio  of  1%  to  or  from  any  main  rale  takes 
us  almost  exactly  half  way  to  the  next  rate.  In  point  of  fact  it 
takes  us  a  shade  beyond  the  half  way  point.  The  lender  will  doubt- 
less be  interested  to  note  that  BUCl  fractions  as  Vfrj,  %2,  '-;i.  etc.,  are 
also  employed  on  occasion. 


96  FOREIGN  EXCHANGE 

grams  of  gold  94b  fine.  It  is  divided  into  100  pfennigs. 
The  mark  has  a  "value,"  as  measured  in  gold  contents, 
of  about  '_':!. Sc.  The  table  on  page  75  shows  demand  drafts 
on  Germany  opening  at  95:)u\  less  b-,4.  As  in  the  case  of 
the  quotations  on  France,  the  rate  here  consists  of  a  main 
price  and  a  supplemental  fraction.  The  German  quota- 
tions, however,  are  not  so  deceiving  as  the  French,  for  the 
main  price  is  a  direct  rate,  namely  the  number  of  American 
cents  asked  for  4  marks.  The  apparent  reason  for  choos- 
ing 4  marks  for  quotation  instead  of  1,  is  that  4  marks  is 
nearly  the  equivalent  of  1  dollar.  Since  the  rate  is  quoted 
in  the  direct  manner,  it  is  cheaper  when  lower  and  dearer 
when  higher,  in  this  respect  being  like  the  sterling  quota- 
tion. 

Suppose  a  buyer  desires  a  bill  for  128,000  marks  at  the 
rate  of  05%6  less  Vm.  Beneath  is  shown  the  method  of 
calculating  the  price  of  this  bill  without  the  use  of  tables. 
128,000  marks  contains  32,000  (128,000-1-4)  units  of  four 
marks.  32,000  units  (of  4  marks  each)  at  95%e^  each, 
would  cost  $30,460,  calculated  as  follows : 

95%6  =  95.1875  =  $0.951875 

.951875       dollars  per  unit 

32,000 units  bought 


1903.750000 
28556.25 


30460.000000 cost  of  bill  in  dollars. 

The  supplementary  fraction,  less  V&i,  gives  the  purchaser 
a  right  to  a  reduction  or  rebate  of  V&i  of  1%. 

1%  of    $30,460.00  =  $304.60 
%4th  of         304.60=       4.75 

The  final  price  of  the  bill,  therefore,  will  be  $30,460.00  less 
$4.75  or  $30,455.25.     German  exchange  is  commonly  quoted 


THE  RATES  OF  EXCHANGE  97 

by  interior  banks  in  the  United  States  in  cents  for  1  mark, 
or  the  number  of  dollars  for  100  marks. 

The  monetary  unit  of  Holland  is  the  guilder,  called  also 
the  gulden  or  the  florin.  Measured  according  to  metallic 
contents,  1  guilder  =  $.402  —  ,  or  $1  =  2.48  +  guilders. 
Bills  of  exchange  payable  in  guilders  are  quoted  at  so 
many  American  cents 'per  guilder.  Sometimes  guilders  are 
quoted  in  cents  and  eighths  of  cents  with  supplementary 
fractions  similar  to  those  used  in  the  French  and  German 
rates. 

With  respect  to  New  York's  rates  on  the  less  important 
countries,  we  may  content  ourselves  with  the  general  state- 
ment that  Italian,  Swiss  and  Belgian  exchange  is  quoted 
in  the  same  manner  as  the  French.  Italy,  Switzerland 
and  Belgium  have  money  units  with  the  same  metallic 
contents  as  the  French.  Exchange  on  Spain,  Austria- 
Hungary,  the  Scandanavian  countries,  Russia,  and  other 
lands  in  general,  is  regularly  quoted  as  the  amount  of 
American  money  to  be  paid  for  one  foreign  unit. 

Exchange  on  London,  taking  the  world  at  large,  is  almost 
always  quoted  in  the  simplest  and  most  direct  manner  by 
giving  the  number  of  local  monetary  units  payable  for  one 
pound  of  draft  or  telegraphic  transfer  as  the  case  may  be. 
London  itself,  on  the  other  hand,  quotes  exchange  on  coun- 
tries foreign  to  Great  Britain  in  most  instances  in  the 
indirect  fashion.  Thus  when  Paris  on  London  stands  at  say 
25.20,  London  on  Paris  will  be  also  at  25.20  or  some  figure 
very  close  to  this ! 


CHAPTER  VI 

THE  DOCUMENTARY  TRADE  BILL 

§  30.  The  documentary  bill  of  exchange. — The  documen- 
tary bill,  or  documentary  draft,  is  a  bill  of  exchange  to 
which  a  bill  of  lading  and  usually  certain  other  incidental 
documents  are  attached  primarily  for  the  purpose  of  serv- 
ing as  collateral  security.  Not  infrequently  the  seller  of 
stocks  or  bonds  to  a  foreign  purchaser  draws  upon  the 
latter,  commonly  at  sight,  and  attaches  the  certificate  of 
stock  or  the  bonds  to  the  draft  in  part  to  serve  as  collateral. 
A  draft  made  up  in  this  manner  should  probably  be  called 
a  documentary  bill,  but  ordinarily  one  would  mean  bj'  this 
term  the  draft  of  a  merchant  with  a  bill  of  lading  attached. 

When  a  draft  is  drawn  by  a  seller  of  merchandise  as  a 
means  of  obtaining  the  sale  price,  we  speak  of  the  instru- 
ment as  being  drawn  "against"  the  merchandise,  or 
"against"  its  shipment,  while  we  say  it  is  drawn  "upon" 
the  person  who  is  drawee.  As  one  would  suppose,  typically 
the  bill  of  lading  attached  to  a  draft  is  the  one  covering  the 
particular  lot  of  goods  against  which  or  on  account  of 
which  the  draft  in  question  is  drawn.  The  legal  effect  of 
attaching  the  bill  of  lading  is,  in  brief,  to  enable  the  holder 
of  the  draft  to  resort  to  the  merchandise  in  case  the  draft 
should  be  dishonored.1  The  vast  majority  of  foreign  bills 
of  exchange  drawn  by  merchants  are  documentary  drafts, 
and  this  holds  good  equally  whether  the  merchant  draws 
upon   another  merchant,   namely   the   importer,    and   thus 

i  The  chief  discussion  of  the  nature  of  the  rights  of  the  holder 
of  the  draft  running  against  the  merchandise,  will  be  found  in 
§  42  below. 

98 


THE  DOCUMENTARY  TRADE  BILL  99 

creates  a  "trade  bill,"  or  draws  upon  a  bank  under  a  letter 
of  credit.2 

The  first  reason  for  attaching  documents. — Speaking  at 
present  of  the  trade  bill,  there  are  two  reasons  for  attaching 
the  shipping  documents.  The  first  is  to  give  to  the  banker 
or  other  purchaser  of  the  draft,  a  legal  interest  in  the 
merchandise,  which  will  enable  him,  or  a  holder  subsequent 
to  him,  to  force  the  sale  of  these  goods  in  the  event  of  the 
dishonor  of  the  draft,  and  to  reimburse  himself  so  far  as 
possible  from  the  proceeds  of  this  sale  for  his  failure  to 
collect  the  amount  due  upon  the  instrument.  It  is  to  this 
we  have  reference  when  we  say  the  merchandise  (or  in- 
differently, the  bill  of  lading)  serves  as  collateral  security. 

Collection  and  advance  against  collections. — It  should  be 
stated,  however,  that  a  bank  is  by  no  means  always  a  pur- 
chaser of  a  draft  which  it  takes  from  the  drawer  or  holder 
subsequent  to  the  drawer.  Often  the  instrument  is  taken 
"for  collection"  only.  This  signifies  that  the  one  who  de- 
posits it  with  the  bank  is  to  receive  the  proceeds  which  it 
will  yield,  only  after  the  drawee  has  made  payment  and 
the  amount  so  paid  has  been  returned  to  the  collecting  bank. 
Banks  receive  drafts  for  collection  generally  in  cases  where 
they  do  not  care  to  make  outright  purchases  of  the  instru- 
ments. But  in  these  instances  they  are  often  willing  to 
make  a  cash  advance  of  an  amount  somewhat  less  than  the 
expected  returns  from  the  instrument,  especially  if  the  de- 
positor is  a  regular  customer  in  good  standing.  These  loans 
or  advances  are  made  at  a  stipulated  rate  of  interest  and 
against  the  deposited  draft,  and  the  proceeds  which  it 
yields,  as  security. 

A  second  reason  for  attaching  documents. — There   is  a 

2  The  term  "trade  bill"  is  here  used  to  signify  a  draft  <>f  a  mer- 
chant on  a  merchant,  though  it  might  be  used  more  broadly  t<>  cover 
any  draft  originating  in  trade  and  thus  the  documentary  draft  of 
a  merchant  on  a  bank. 


100  FOREIGN  EXCHANGE 

second  reason  for  attaching  the  documents  to  a  draft,  in 
addition  to  the  one  that  they  may  serve  as  collateral  se- 
curity, and  this  reason  holds  good  even  where  the  draft  is 
deposited  for  collection  without  an  advance  against  it.  The 
importer,  or  man  at  the  other  end  of  the  mercantile  trans- 
action from  the  drawer,  cannot  obtain  his  goods  until  he 
procures  the  bill  of  lading  properly  indorsed.  The  exporter 
safeguards  his  interests  by  putting  this  document  in  the 
hands  of  the  holder  or  custodian  of  the  draft,  with  appro- 
priate instructions,  so  that  the  importer  cannot  get  the 
goods  until  he  has  received  presentment  of  the  draft  and 
has  honored  it,  either  as  in  some  cases  by  acceptance  merely, 
or  as  in  most  cases  by  acceptance  and  payment  both.  Thus 
even  if  purchasing  banks  did  not  demand  the  bill  of  lading 
as  their  own  collateral  security,  the  exporter  would  still 
have  a  motive  to  make  up  a  documentary  draft,  as  this  plan 
furnishes  him  with  more  protection  against  loss  through 
fraud  or  failure  on  the  part  of  the  importer,  than  the  alter- 
native plan  of  sending  the  bill  of  lading  direct  to  the  im- 
porter through  the  mails  and  independently  of  the  draft. 

Clean  bills. — It  is  not  to  be  understood  that  between  ex- 
porters and  importers  of  standing,  especially  where  there 
are  established  relations,  bills  of  lading  are  not  sometimes 
mailed  direct  and  independently  of  drafts.  Sometimes  the 
exporter  sends  the  bill  of  lading  along  and  draws  separately, 
and  at  other  times  he  may  send  it  without  drawing  at  all  un- 
der an  agreement  that  the  importer  will  subsequently  remit 
exchange  in  payment.  (In  many  instances  the  importer  will 
be  asked  to  remit  in  advance.)  If  a  bill  of  exchange  does 
not  have  documents  attached  it  is  known  as  a  "clean  bill." 
All  bills  drawn  by  purely  banking  houses  are  clean.  If 
a  bill  begins  its  life  with  documents  attached  but  these  are 
detached  before  its  discharge,  it  becomes  for  the  last  part 
of  its  life  a  clean  bill.  It  is  rare  for  a  documentary  draft 
on  a  merchant  to  become  a  clean  bill  before  the  drawee 


THE  DOCUMENTARY  TRADE  BILL  101 

grants  acceptance  to  the  instrument,  If  a  merchant  can  sell 
a  clean  bill  on  another  merchant  it  will  be  because  of  his, 
the  drawer's,  high  standing-  before  the  banks. 

The  several  documents  attached. — The  principal  papers 
which  constitute  what  we  may  call  the  standard  documen- 
tary bill  are  (1)  the  draft,  (2)  the  bill  of  lading,  (3)  the 
insurance  certificate,  (4)  the  hypothecation  certificate  (un- 
less the  hypothecation  is  provided  for  by  a  general  letter  of 
Irypothecation),  and  (5)  various  other  documents  including 
at  times  certain  consular  and  inspection  certificates,  and 
including  often  the  invoice,  or  bill  of  goods.  A  special 
document  of  hypothecation  or  pledge  (compare  §  33)  is 
not  necessarily  present,  the  mere  delivery  of  the  bill  of 
lading  being  taken  to  effect  a  pledge  without  the  execution 
of  special  acknowledgments  to  this  intent. 

The  terms  of  the  sale  and  the  draft. — In  general  the 
terms  and  character  of  a  draft  are  governed  by  the  under- 
standing existing  between  the  buyer  and  seller  of  the  goods. 
This  understanding  may  be  expressed  or  it  may  be  implied 
in  the  usages  of  the  trade.  Again  it  may  unfortunately  be 
non-existent,  which  often  means  trouble.  A  demand  draft 
may  of  course  be  drawn  with  documents  attached.  So  far 
as  the  bill  of  exchange  has  been  used  by  American  domestic 
shippers,  demand  drafts  or  drafts  with  very  short  lives  have 
been  chiefly  employed.  It  is  the  hope  of  our  Federal  Re- 
serve Banks  to  establish  the  free  use  of  long  documentary 
bills  in  American  internal  commerce  in  the  future,  and  this 
hope  is  already  beginning  to  be  realized.  In  foreign  trade 
the  usual  documentary  bill  runs  for  sixty  or  ninety  days  if 
not  for  a  longer  term.  The  amount  of  the  draft  is  com- 
monly the  total  sum  for  which  the  goods  arc  sold  but  oc- 
casionally a  certain  prearranged  percentage  of  this  sum. 

Bills  in  sets. — The  foreign  trade  bill,  like  most  other 
foreign  drafts,  is  regularly  drawn   in  a   plural   number  of 


102  FOREKiX  EXCHANGE 

copies,  in  " duplicate "  or  "triplicate."  Whon  drafts  are 
thus  issued  "in  a  set,"  one  of  them  will  be  marked  "first 
of  exchange"  or  "original,"  another  "second  of  exchange" 
or  "duplicate"  and  so  on.  The  first  of  exchange  will  read 
as  an  order  to  pay  "second  and  third  unpaid"  (i.e.,  pro- 
vided neither  second  nor  third  of  exchange  have  been  paid), 
and  so  forth,  so  that  the  payment  of  any  one  copy  has  the 
legal  effect  of  making  other  copies  void.  The  law  makes 
possible  the  issue  of  bills  in  sets  of  any  number  of  copies 
desired.  The  issue  of  bills  in  sets  is  taken  advantage  of 
for  various  purposes.  One  object  is  to  enable  the  holder 
to  forward  the  first  and  second  of  exchange  by  separate 
steamers  as  a  measure  of  safety.  A  third  of  exchange  when 
issued  is  likely  to  be  kept  by  the  holder  as  a  matter  of 
record.  A  bill  of  lading  is  also  issued  in  as  large  a  num- 
ber of  copies  as  desired,  but  these  are  not  marked  "first," 
"second,"  and  so  on.  Any  one  of  these  copies  is,  when 
properly  indorsed,  good  for  the  merchandise  at  the  terminal. 
The  holder  of  a  documentary  draft  has  to  see  to  it  that  he 
has  control  of  or  knows  what  is  done  with  all  the  copies 
of  the  bill  of  lading. 

§  31.  The  bill  of  lading. — A  bill  of  lading  is  the  written 
acknowledgment  of  a  transportation  company  of  the  receipt 
of  goods  for  carriage  to  a  designated  place.  The  instru- 
ment contains  a  description  of  the  goods,  with  a  record  of 
packages  and  marks,  if  any,  to  identify  them,  and  a  recital 
of  the  terms  of  agreement  with  the  shipper  under  which 
the  company  undertakes  the  forwarding.  The  shipper  is 
also  known  as  the  consignor  and  the  one  to  whom  the  goods 
are  sent  as  the'  consignee.  To  ship  is  as  well  to  consign,  and 
a  shipment  is  also  a  consignment.  In  a  narrower  but 
fairly  common  commercial  sense,  "to  consign"  means  to 
ship  property  to  a  person  for  sale  or  reshipment  by  him  as 
a  mere  agent  or  factor  of  the  shipper.  If  A  sends  goods 
to  B  "on  consignment"  in  this  sense,  B  is  not  an  independ- 


THE  DOCUMENTARY  TRADE  BILL  103 

ent  purchaser  of  the  goods  but  is  an  agent  of  A,  and  A 
takes  the  mercantile  risks.  The  consignee  as  we  are  to 
speak  of  him  in  the  present  connection,  however,  is  simply 
the  person  to  whom  goods  are  shipped,  whether  he  is  an 
independent  purchaser  or  a  mere  agent  of  the  shipper. 

Distinguished  according  to  their  manner  of  indicating  the 
person  to  whom  the  goods  are  made  deliverable,  there  are 
two  classes  of  bills  of  lading.  To  quote  the  Federal  Bills 
of  Lading  Act  of  August  29,  1916,  "a  bill  in  which  it  is 
stated  that  the  goods  are  consigned  or  destined  to  a  specified 
person  is  a  straight  bill.  ...  A  bill  in  which  it  is  stated 
that  the  goods  are  consigned  or  destined  to  the  order  of 
any  person  named  in  such  bill  is  an  order  bill."3  The 
order  bill  is  the  one  in  proper  form  for  use  as  collateral 
security  and  consequently  the  export  bill  of  lading  almost 
always  takes  this  form  because  it  is  designed  to  be  attached 
to  a  draft.  Such  a  bill  will  make  the  goods  deliverable 
either  to  the  order  of  the  shipper  himself  or  to  the  order 
of  some  bank  which  is  about  to  finance  or  help  finance  the 
export  whether  through  the  direct  purchase  oi  the  ex- 
porter's draft  or  through  the  issue  of  a  commercial  letter 
of  credit.  If  the  bill  of  lading  reads  to  the  order  of  the 
shipper  himself,  the  transportation  company  will  surrender 
the  goods  only  to  the  person  to  whom  the  shipper  orders 
them  delivered.  This  order  is  conveyed  by  an  indorsement 
on  the  bill  of  lading  itself.  But  this  indorsement  may  be 
either  (1)  in  blank  or  (2)  to  a  specified  person.'1  In  the 
latter  case  the  person  designated  may  himself  indorse  again 
either  in  blank  or  specially,  and  thus  again   transfer  Hie 

3  §§  2  and  3  of  the  act.  The  text  of  this  act,  which  went  into 
effect  January  1,  L917,  may  he  found  anions  other  places  in  I  lie 
Federal  Reserve  Bulletin  for  October,  l!)l(i,  issued  by  tin-  Federal 
Reserve  Board,  Washington,  D.  C. 

*  Compare  the  indorsement  in  blank  and  special  indorsement  of 
bills  of  exchange  and  promissory  notes,  as  described  in  §  11. 


104  FOREIGN  EXCHANGE 

bill  of  Lading  and  the  right  to  receive  the  merchandise. 
But  the  standard  form  of  indorsement  of  export  bills  made 
out  to  the  order  of  the  shipper  is  in  blank.  As  one  could 
infer,  this  indorsement  is  constituted  by  the  shipper's  signa- 
ture without  a  specification  of  the  person  to  whom  the 
goods  are  to  be  delivered,  the  place  for  this  person 's  name 
being  left  blank.  This  indorsement  has  the  effect  of  making 
the  goods  deliverable  to  any  rightful  holder  of  the  bill  of 
lading,  who  may  procure  them  (commonly  of  course  at 
destination)  by  writing  his  own  name  in  the  blank  place. 
If  A  exports  goods  and  procures  a  bill  of  lading  to  his  own 
order  and  indorses  the  latter  in  blank,  he  may  then  make 
up  a  documentary  draft  for  sale  to  a  local  bank.  The  bill 
of  lading  will  remain  in  the  possession  of  this  bank  and  its 
foreign  agents  (or  successors)  until  delivered  to  the  im- 
porter and  drawee  of  the  draft,  under  the  documentary 
instructions.5 

"We  maj*  call  the  importing  merchant  the  real  consignee 
for  it  is  to  him  the  goods  are  really  being  shipped  and  to 
him  they  will  in  fact  be  delivered  if  he  performs  his  duties 
towards  the  exporter's  draft.  But  as  has  just  been  ex- 
plained, this  real  consignee's  name  does  not  appear  origi- 
nally upon  the  regular  export  bill  as  the  party  to  take  de- 
livery of  the  merchandise.  This  is  to  prevent  him  gaining 
any  rights  that  w'ould  interfere  with  the  use  of  the  bill  and 
the  goods  to  which  it  pertains,  as  collateral  security  for  the 
exporter's  draft.  It  is  nevertheless  expected  that  in  fact 
he  will  be  the  one  to  take  delivery  of  the  goods,  and  it  is 
necessary  that  upon  their  arrival  at  destination  he  should 
be  informed  of  the  event  by  the  transportation  company. 
In  order  that  he  may  be  known  for  this  purpose,  his  name 
will  be  entered  upon  the  bill  of  lading  when  originally 
made  out,  not  as  consignee  but  as  the  "party  to  be  notified." 
Although  every  one  knows  that  this  indicates  a  commercial 

s  See  §  34  below. 


THE  DOCUMENTARY  TRADE  BILL  105 

expectation  that  this  person  will  receive  the  goods,  it  does 
not  give  him  any  rights  in  advance  of  his  performance  of 
his  duties  towards  the  exporter's  draft,  which  will  be  preju- 
dicial to  the  rights  of  the  banker  as  holder  of  the  bill  of  lad- 
ing as  collateral  security.6 

Much  merchandise  for  export  is  shipped  over  the  lines  of 
more  than  one  transportation  company.  There  is  often  in- 
volved at  least  one  railroad  company  and  one  separate  ocean 
steamship  company.  In  these  instances  the  company  first 
receiving  the  goods  is  usually  ready  to  issue  a  "through" 
bill  of  lading  which  will  relieve  the  consignor  of  the  neces- 
sity of  attending  to  trans-shipment  at  the  point  where  the 
second  company  takes  over  the  goods  for  further  carriage. 
That  is,  the  through  bill  of  itself  gives  a  claim  against  the 
last?transportation  company  for  the  goods  at  destination. 
Through  bills  cannot  be  obtained  for  all  routes  or  all  classes 
of  merchandise,  but  are  generally  available,  and  are  espe- 
cially convenient  to  merchants  and  banks  in  the  making  up 
and  negotiation  of  documentary  drafts.  Nevertheless  a 
documentary  draft  can  be  handled  without  the  bill  of  lading 
being  through,  although  there  will  be  in  this  case  a  certain 
amount  of  expense  and  trouble  incidental  to  trans-shipment. 
Typically  the  bank  which  holds  the  documentary  draft  takes 
charge  of  the  trans-shipment  and  employs  brokers  in  the  city 
of  trans-shipment  to  take  care  of  cartage  and  rebilling.  In 
large  cities  +«*i-  seaports  brokers  are  found  who  make  it 
their  business  to  attend  to  matters  of  this  sort,  the  payment 
of  customs  duties  on  imports,  and  the  like. 

Though  the  through  bill  is  convenient,  there  are  many 
occasions  when  it  is  not  taken  out  even  where  it  can  be  had, 
because  of  the  great  chances  of  delay  when  trans-shipmenl  is 
left  in  the  hands  of  the  railway  or  steamship  company. 
Also  in  this  connection  the  following  may  be  noted   from 

6  This  legal  principle  is  written  into  the  Federal  Bills  of  Lading 
Ait,  in  llic  seventh  section  of  that  law. 


L06  FOREIGN  EXCHANGE 

Mr.  A.  J.  Wol IT's  report  on  Foreign  Credits.7  "Ranks 
abroad  very  often  refuse  acceptance  of  bills  drawn  against 
railway  through  bills  of  lading,  because  they  object  to  bills 
of  lading  signed  by  an  ordinary  railway  employee,  and  also 
because  the  actual  departure  from  port  is  not  apparent 
therefrom."  The  first  of  these  reasons  has  been  removed, 
or  at  least  much  reduced  in  force,  so  far  as  exports  from 
the  United  States  are  concerned,  by  the  new  Federal  Bills 
of  Lading  Act,  already  mentioned,  which  places  upon  rail- 
way companies  a  sufficient  responsibility  for  the  signatures 
of  their  agents,  a  responsibility  apparently  lacking  under 
common  law.8  A  substantially  similar  act  has  also  been 
passed  by  states  numbering  16  at  the  present  time.  The 
standard  export  bill  to  which  this  section  has  been  devoted, 
rejoices  in  the  full  name  of  the  through  order  notify  export 
oill  of  lading. 

§  32.  The  insurance  certificate. — The  next  member  of  the 
group  of  instruments  constituting  the  documentary  bill  is 
the  insurance  certificate.  Generally  speaking,  merchandise 
for  export  is  not  specially  insured  for  the  inland  part  of  its 
haul,9  because  the  liabilities  assumed  by  railway  companies 
take  the  place  of  insurance.  But  the  ocean  transport  lines 
do  not  take  on  these  liabilities  and  shippers  procure  insur- 
ance against  loss  at  sea  from  the  regular  marine  insurance 
companies.  This  can  regularly  be  obtained  on  the  mere 
evidence  of  the  bill  of  lading.  It  is  the  recognized  custom 
to  permit  insurance  for  sums  from  10  to  20%  in  excess 
of  the  invoice  value  of  the  goods,  to  cover  expected 
mercantile  profits.  Like  the  bill  of  lading,  the  insurance 
certificate  is  made  out  to  the  order  of  the  shipper  and  in- 
dorsed by  him  in  blank.     Large  houses  enjoying  the  con- 

?  "Foreign   Credits,"   by  A.   J.  Wolff,   Special  Agents'   Series,  No. 
62,  U.  S.  Department  of  Commerce  and  Labor,  p.   110. 
s  See  especially  §  22  of  this  act. 
9  To  this  there  are  exceptions. 


THE  DOCUMENTARY  TRADE  BILL  107 

fidence  of  the  insurance  companies,  often  obtain  what  are 
known  as  "open  policies,"  under  which  they  are  permitted 
themselves  to  issue  insurance  certificates  to  their  own  order 
against  their  consignments  of  merchandise  as  shipped. 
This  plan  saves  the  time  and  labor  required  to  make  a 
special  application  for  insurance  against  each  and  every 
shipment  of  goods.  Premiums  due  under  these  open  poli- 
cies will  be  paid  at  stated  intervals.  The  insurance  com- 
pany is  of  course  to  receive  an  advice  for  each  certificate  of 
insurance  issued  by  the  merchant  to  himself. 

Insurance  may  often  be  obtained  abroad  at  lower  rates, 
and  therefore  it  is  not  uncommon  for  an  arrangement  to  be 
made  to  have  the  consignee  of  the  goods  procure  the  policy. 
In  these  cases-  the  shipper  has  no  insurance  certificate  to 
put  in  his  documentary  bill,  but  with  the  agreement  of  the 
purchaser,  he  substitutes  a  written  statement  "insurance 
effected  abroad." 

§  33.  The  hypothecation  certificate  and  other  documents. — 
The  hypothecation  certificate  is  the  instrument  in  which  the 
drawer  of  the  draft  makes  the  legal  acknowledgments  which 
constitute  any  holder  of  the  draft  also  a  holder  of  the  bill 
of  lading  and  insurance  certificate  as  collateral  security. 
As  stated  on  an  earlier  page,  in  practice  these  express 
acknowledgments  are  not  always  regarded  as  indispensable 
in  making  up  documentary  bills.  To  "hypothecate" 
means  to  give  personal  property  as  a  pledge  to  secure  a 
debt  or  liability.  But  not  every  case  of  so-called  hypothe- 
cation in  banking  practice  would  seem  to  be  a  strict  legal 
pledge,  for  the  banker  not  infrequently  secures  a  title  to 
the  goods,  which  is  inconsistent  with  a  pledge  pure  and 
simple.  However,  following  the  looser  usages  of  commer- 
cial speech,  we  may  say  that  the  hypothecation  certificate 
is  the  formal  legal  recital  which  pledges  the  bill  <>l*  Lading 
and  the  merchandise  covered  by  it,  as  collateral  security 
for  the  draft.     If  a  bank  expects  to  purchase  from  a  given 


108  FOREIGN  EXCHANGE 

li tin  a  large  number  of  documentary  drafts,  it  often  takes 
from  this  firm  a  general  letter  of  hypothecation  or  general 
hypothecation  power.  This  instrument  will  cover  all  bills 
of  exchange  with  collateral  security,  which  are  negotiated 
by  its  issuer  to  the  bank  during  the  life  of  the  letter.  It 
saves  the  labor  of  drawing  up  a  separate  certificate  of 
hypothecation  for  each  and  every  bill.  When  there  is  such 
a  separate  certificate  it  is  attached  to  the  draft  along  with 
the  other  documents. 

The  specimen  letter  of  hypothecation  to  follow  is  one  in 
actual  use  by  an  American  bank  though  the  name  of  the 
institution  is  omitted.  It  is  given  in  full  because  of  the 
great  practical  interest  of  its  numerous  provisions. 

General  Letter  of  Hypothecation 

To  The  Hundredth  National  Bank  of  New  York: 

Anticipating  all  future  sales  to  you  and  all  future  negotiations 
by  you  for  the  undersigned,  of  bills  of  exchange  with  shipping 
documents  for  goods  or  other  property  attached  as  collateral  se- 
curity and  held  by  you  for  their  due  payment,  it  has  been  and  is 
agreed  between  us  as  follows: 

1.  The  stipulations  contained  in  this  Memorandum  shall  be 
deemed  to  be  continuing  and  ambulatory,  and  are  to  apply  to  all 
cases  in  which  such  bills  of  exchange  may  at  any  time  either 
directly,  or  through  other  persons,  be  negotiated  with  or  sold  to 
you  by  the  undersigned,  and  this  Memorandum  shall  have  the 
same  force  until  the  undersigned  shall  give  you  notice  of  inten- 
tion to  terminate  it,  as  if  a  separate  Memorandum  were  signed  by 
the  undersigned  on  each  purchase  or  negotiation. 

2.  You  may  (but  it  is  not  imperative  on  you  to  do  so)  insure 
any  goods  or  property  of  any  kind  forming  the  collateral  secur- 
ity for  any  such  bill  or  bills  of  exchange  from  sea  risk  and  risk 
of  transportation  by  land,  including  loss  by  capture,  and  also 
from  loss  by  fire  on  shore,  and  add  the  premiums  and  expenses 
of  such  insurances  to  the  amount  chargeable  to  the  undersigned 
in  respect  of  such  bill  or  bills,  and  take  recourse  upon  such  goods 
in  priority  to  any  other  claims  thereon,  or  against  the  under- 


THE  DOCUMENTARY  TRADE  BILL  109 

signed,  without  prejudice  to  any  claim  against  any  indorser  or 
indorsers  of  the  said  bills,  for  reimbursing  you,  or  the  person  or 
persons  paying  the  same,  the  amount  of  such  premiums  and  ex- 
penses,  and  you  may  sell  any  portion  of  such  goods  which  may 
be  necessary  for  payment  of  freight,  insurance  and  expenses, 
and  generally  take  such  measures  and  make  such  charges  for 
commission,  and  be  accountable  in  such  manner,  but  not  further 
or  otherwise  than  as  in  ordinary  cases  between  a  merchant  and 
his  correspondent.  And  the  undersigned  consent  to  the  goods 
being  warehoused  at  any  public  or  private  wharf  or  warehouse 
selected  by  the  Drawees  or  Acceptors  of  the  bills,  unless  you 
offer  an  objection  to  such  wharf  or  warehouse. 

3.  You  may  take  conditional  acceptances  to  all  or  any  of  such 
bills,  to  the  effect  that,  on  payment  thereof  at  maturity,  or  under 
discount,  the  Documents  handed  to  you  as  collateral  security  for 
the  due  payment  of  such  bill  or  bills  shall  be  delivered  to  the 
Drawees  or  Acceptors  thereof,  and  authorization  shall  be  taken 
to  extend  to  cases  of  acceptance  for  honor.  Subject,  neverthe- 
less, to  the  power  hereinafter  given,  in  case  the  drawee  shall 
suspend  payment,  become  bankrupt,  or  go  into  liquidation  dur- 
ing the  currency  of  any  such  bill  or  bills. 

4.  You  may  at  any  time  or  times  before  the  maturity  of  any 
bill  or  bills  of  exchange,  as  aforesaid,  grant  a  partial  delivery  or 
partial  deliveries  from  time  to  time  of  any  part  or  parts  of  such 
goods  or  other  property  in  such  manner  as  you  or  the  Acceptors 
of  such  bill  or  bills  of  exchange,  or  their  representatives,  may 
think  desirable  to  any  person  or  persons  on  payment  of  a  pro- 
portionate amount  of  the  invoice  cost  of  such  goods,  or  other 
property,  or  of  the  bill  or  bills  of  exchange  drawn  against  the 
same. 

5.  In  case  default  be  made  in  acceptance  of  the  said  bills  on 
presentation,  the  undersigned  immediately  on  receiving  notice 
from  you  that  you  have  been  advised  by  telegraph  or  otherwise 
of  such  non-acceptance,  and  without  waiting  for  or  requiring  the 
protest  of  said  bills,  will  pay  you  the  amount  thereof,  with  all 
charges  of  every  description  incurred  by  you  in  consequence  of 
such  non-acceptance,  and  at  your  option  the  undersigned  will 
give  you  satisfactory  additional  margin  in  cash  or  securities,  all 


110  FOREIGN  EXCHANGE 

in  addition  to  your  possession  in  the  United  Kingdom  or  else- 
where, of  the  goods  or  other  property  securing  said  bills  or  the 
documents  therefor;  and  your  account  of  the  disbursements,  com- 
missions and  charges  so  incurred  shall  be  received  by  the  under- 
signed as  sufficient  and  final  evidence  thereof. 

6.  In  case  detault  be  made  in  acceptance  or  payment  of  any  of 
the  said  bills,  or  if  the  Drawees  or  Acceptors  should  suspend  pay- 
ment, or  be  adjudicated  bankrupt,  or  execute  any  deed  of  ar- 
rangement, composition  or  inspectorship,  or  take  any  other  step 
whatsoever  toward  effecting  a  compromise  or  arrangement  with 
their  creditors  during  the  currency  of  said  bills,  you  may  at  any 
time  after  any  of  the  aforesaid  events  taking  place,  sell  the  goods 
or  other  property  or  any  part  thereof,  without  notice  to  or  the 
concurrence  of  any  person  whomsoever,  without  waiting  for  the 
maturity  of  the  said  bills,  and  either  by  public  auction  or  private 
sale,  and  you  may  act  in  all  respects  as  if  you  had  been  the  direct 
consignee  of  the  goods  or  other  property,  charging  such  commis- 
sion as  is  usual  between  a  merchant  and  his  correspondent  in 
ordinary  cases,  and  shall  apply  the  net  proceeds  of  any  sale, 
after  deducting  any  payment  under  the  powers  herein  contained, 
with  interest  thereon,  and  the  usual  commission  and  charges,  in 
payment  of  the  bills,  with  interest,  re-exchange  and  other  charges, 
and  may  apply  the  balance,  if  any,  toward  the  liquidation  of 
any  other  debt  and  liability  of  ours  to  you,  whether  or  not  the 
same  be  then  payable  or  ascertained,  it  being  hereby  agreed  that 
the  goods  themselves,  or  other  property,  until  sale,  shall  be  liable 
for  and  be  charged  with  the  payment  of  all  such  bills,  with  com- 
mission, interest,  re-exchange  and  other  charges,  debts  and  lia- 
bilities; and  we  agree  that  all  account  sales  and  accounts  current 
furnished  by  you,  in  respect  to  the  said  goods  and  produce,  shall 
be  received  by  us  as  sufficient  and  final  evidence  of  their  ac- 
curacy. 

7.  In  case  the  net  proceeds  of  such  goods  shall  be  insufficient 
to  pay  the  amount  of  any  such  bill  or  bills,  with  re-exchange  and 
charges,  you  may  draw  on  the  undersigned  for  the  deficiency, 
without  prejudice  nevertheless  to  any  claim  against  any  indorser 
or  indorsers  of  the  said  bills  for  recovery  of  the  same  or  any 
deficiency  on  the  same;  and  the  undersigned  agree  to  honor  such 


THE  DOCUMENTARY  TRADE  BILL  111 

drafts  on  presentation,  it  being-  understood  that  the  account  cur. 
rent  rendered  by  you  or  by  the  holder  or  holders  of  such  bill, 
shall  be  sufficient  proof  of  sale  and  loss. 

8.  Whether  the  aforesaid  powers  of  sale  shall  or  shall  not  have 
arisen,  you  may  at  any  time  before  the  maturity  of  any  such  bill 
or  bills,  accept  payment  from  the  drawees  or  acceptors  thereof, 
if  required  so  to  do,  and  on  payment  you  may  deliver  the  bills 
of  lading  and  shipping  documents  to  such  drawees  or  acceptors; 
and,  in  that  event,  you  or  the  holder  or  holders  of  any  such  bill 
or  bills  are  to  allow  a  discount  thereon,  not  exceeding  five  per 
cent,  per  annum,  for  the  time  they  may  have  to  run,  as  follows : 

At  one-half  per  cent,  per  annum  above  the  advertised  rate 
of  interest  for  short  deposits  allowed  by  the  leading  London 
Joint  Stock  Banks,  if  payable  in  Great  Britain. 

At  the  current  minimum  rate  of  discount  of  the  national 
banks  of  France,  Italy,  Belgium  and  Germany,  if  payable  in 
those  countries. 

At  the  current  rate  of  rebate  for  documentary  bills,  if  pay- 
able in  Switzerland. 

At  the  current  rate  of  rebate  allowed  by  the  Exchange  Banks, 
if  payable  at  any  place  east  of  Suez. 

9.  The  delivery  of  any  collateral  securities  to  you  shall  not 
prejudice  your  rights  on  any  such  bills  in  case  of  dishonor,  nor 
shall  any  recourse  taken  thereon  affect  your  title  to  such  securi- 
ties to  the  extent  of  the  liability  of  the  undersigned  to  you  as 
above. 

10.  Notwithstanding  any  alteration  by  death,  retirement,  in- 
troduction of  new  partners  or  otherwise  in  the  persons  from  time 
to  time  constituting  the  firm  of  the  undersigned  or  other  the  style 
or  firm  under  which  the  business  at  present  carried  on  by  the 
undersigned  may  be  from  time  to  time  continued,  this  Led  it  and 
the  powers  and  authorities  hereby  given  are  to  hold  good  as  the 
Agreement  on  the  part  of  the  undersigned  or  of  the  firm  as  afore 
said  with  you,  and  each  negotiation  of  a  bill  or  bills  hereunder 
is  to  be  treated  as  a  renewal  by  or  on  behalf  of  the  under 
signed  and  of  the  firm  as  then  existing  of  the  terms  of  this 
Agreement. 


112  FOREIGN  EXCHANGE 

11.  You  are  not  to  be  responsible  for  the  default  of  any  broker 
or  auctioneer  employed  by  you  for  any  purpose. 

12.  All  rights,  powers  and  authorities  herein  given  to  you 
may  be  exercised  by  you  or  any  of  your  managers  or  agents  or 
the  holder  or  holders  for  the  time  being  of  any  bill  or  bills  of 
exchange  as  aforesaid,  and  all  agreements  and  provisions  con- 
tained in  this  Letter  of  Hypothecation  shall  extend  and  apply  to 
and  for  the  benefit  of  all  holders  for  the  time  being  of  any  such 
bills. 

Dated  this  day  of  one  thousand  nine  hundred  and 

Witness  to  the  signature  of: 

Witness. 

Occupation. 

Address. 

The  letters  of  hypothecation  of  different  American  banks 
appear  to  be  much  alike.  The  writer  of  the  letter  is  the 
drawer  of  the  bills  of  exchange  to  which  the  letter  pertains. 
In  the  foregoing  specimen,  paragraph  6  contains  the  prin- 
cipal clauses  pledging  the  goods  as  collateral,  but  as  we 
see,  there  are  numerous  incidental  provisions  binding  the 
drawer  to  the  bank  or  its  successors  in  various  ways.  The 
chief  among  these  briefly  stated  are  as  follows: 

(a)  The  bank  m&y  insure  the  goods  at  the  drawer's  ex- 
pense. So  far  as  satisfactory  insurance  has  been  provided 
by  the  drawer  or  the  importer  in  advance,  no  resort  to  this 
power  would  be  taken  by  the  bank. 

(b)  The  bank  may  sell  any  portion  of  the  goods  required 
to  pay  any  freight  charges  left  unpaid  by  the  shipper. 

(c)  The  drawer  consents  to  the  selection  of  any  ware- 
house abroad  by  the  importer  which  is  satisfactory  to  the 
bank.  To  illustrate  the  application  of  this  provision,  let  us 
suppose  the  goods  have  arrived  and  have  been  placed  in  a 
warehouse  at  destination,  and  are  then  destroyed  by  fire. 
The  collateral  security  thus  disappears  except  for  the  in- 


THE  DOCUMENTARY  TRADE  BILL  113 

suranee.  Suppose  further  the  drawee  of  the  draft  (the  im- 
porter) now  refuses  to  honor  the  instrument,  whether 
through  financial  inability  or  for  other  reasons.  The  pro- 
vision now  before  us  will  have  the  effect  of  preventing  the 
drawer  (or  exporter)  from  setting  up  any  counterclaim 
based  on  alleged  improper  warehousing  of  his  merchan- 
dise, when  the  holder  of  the  draft  exercises  his  right  of 
recourse.  The  drawer  has  expressly  estopped  himself  from 
setting  up  such  a  claim.  If  he  pays  the  draft  and  all  in- 
cidental charges  connected  with  it  and  the  merchandise, 
the  insurance  will  belong  to  him.  If  this  insurance  is 
good  he  will  have  to  wait  till  it  can  be  collected.  If  it 
should  turn  out  to  be  uncollectable,  it  will  be  his  loss,  unless 
he  should  be  able  ultimately  to  obtain  reimbursement 
through  some  action  against  the  importer.  In  a  word  it 
is  agreed  that  the  exporter  who  sells  his  draft  to  the  bank, 
and  not  the  bank,  is  to  take  the  risks  connected  with  the 
merchandise. 

(d)  The  bank  may  take  from  the  drawee  a  conditional 
acceptance,  where  the  condition  is  that  the  documents  must 
be  delivered  to  the  drawee  for  the  act  of  payment.  (We 
shall  speak  of  this  point  in  a  moment.) 

(e)  The  bank  may  grant  the  acceptor  partial  deliveries 
from  the  consignment  of  goods  in  return  for  payment  by 
him  of  a  proportionate  amount  on  account.  (Such  com- 
ment as  we  have  to  make  on  this  subject  is  best  reserved 
for  §  36.) 

(f )  In  paragraph  5,  protest  for  non-acceptance  (compare 
§  12)  is  waived,  but  the  letter  does  not  make  it  certain  that 
protest  for  non-payment  is  waived.  Without  this  waiver 
protest  would  be  necessary  to  prevent  the  drawer  from 
escaping  all  his  liabilities  on  the  draft  except  his  vendor's 
warranties  (compare  again  §  12). 

(g)  If  in  case  of  non-acceptance  or  non-payment  of  the 
draft,  the  net  proceeds  of  the  sale  of  the  goods  prove  in- 


114  FOREIGN  EXCHANGE 

sufficient  to  pay  the  amount  due  on  the  draft  plus  charges 
and  commissions,  the  drawer  agrees  to  honor  a  draft  to  be 
drawn  upon  him  for  the  amount  of  the  deficiency. 

(h)  In  the  event  of  sale  of  the  goods  hy  the  bank,  the 
sale  may  be  public  or  private,  and  the  bank  is  to  be  free 
of  responsibility  for  default  by  any  broker  who  makes  the 
sale. 

(i)  The  bank's  account  of  charges  and  commissions  is 
to  be  final  and  not  subject  to  contest. 

(j)  All  rights  and  powers  granted  the  bank  in  the  letter 
of  hypothecation  are  granted  any  subsequent  holder  of  a 
draft  drawn  under  it  for  the  time  he  holds  it. 

We  have  seen  that  this  letter  authorizes  the  holder  of  a 
draft  to  take  a  "conditional"  acceptance  of  a  specified 
character.  Acceptances  have  already  been  discussed  in 
§§6  and  12.  They  are  either  general  or  qualified.  A  gen- 
eral acceptance,  the  kind  ordinarily  given,  "assents  with- 
out qualification  to  the  order  of  the  drawer. " 10  It  makes 
the  drawee  unconditionally  bound  to  pay  the  instrument 
according  to  its  tenor.  A  qualified  acceptance  makes  pay- 
ment depend  upon  some  condition  specified  in  the  accept- 
ance (this  giving  us  the  "conditional"  acceptance)  or  it 
binds  the  acceptor  to  pay  only  part  of  the  amount  for  which 
the  bill  is  drawn  (this  giving  us  the  "partial"  acceptance), 
or  it  modifies  the  liability  of  the  acceptor  in  some  other 
way.11  We  have  already  learned  that  the  right  of  recourse 
upon  the  indorsers  or  drawer  of  a  bill  as  parties  second- 
arily liable,  is  dependent  upon  (1)  proper  presentment 
(2)  dishonor,  whether  for  non-acceptance  or  for  non-pay- 
ment, and  (3)  due  notice  of  dishonor.  Suppose  now  on 
presentment  of  the  bill  the  drawee  is  willing  to  give  only  a 

io  See  §  227  of  the  Uniform  Negotiable  Instruments  Law,  as  al- 
ready cited. 

ii  §  229  of  the  Uniform  Law. 


THE  DOCUMENTARY  TRADE  BILL  115 

qualified  or  conditional  acceptance.  Will  or  will  not  this 
operate  as  dishonor  for  non-acceptance?  The  answer  is, 
the  holder  may  treat  the  instrument  as  dishonored  in  this 
event  and  exercise  an  immediate  right  of  recourse  upon  the 
parties  secondarily  liable.  In  other  words,  the  law  gives 
him  a  right  either  to  receive  an  unqualified  acceptance 
or  to  have  recourse.  He  may  take  a  qualified  or  condi- 
tional acceptance  at  his  own  option  (upon  the  supposition 
perhaps  that  it  will  be  sufficiently  binding  on  the  acceptor 
under  the  practical  circumstances),  but  the  effect  will  be 
to  release  the  parties  secondarily  liable  at  once  and  for  all 
time  (except  for  such  lesser  liabilities  as  may  remain  under 
their  vendor's  warranties).12  Without  the  consent  of  the 
parties  secondarily  liable,  the  holder  cannot  acquiesce  in 
a  qualified  acceptance  and  retain  his  rights  of  recourse 
upon  these  parties.  The  type  of  conditional  acceptance 
authorized  by  the  letter  of  hypothecation  now  before  us, 
is  one  framed  in  any  words  conveying  the  meaning  "I, 
the  drawee,  bind  myself  to  make  payment  of  this  bill  pro- 
vided at  the  time  of  payment,  if  not  before,  the  documents 
attached  to  it  as  collateral  security  are  surrendered  to  me." 
The  motive  an  importer  might  have  for  insisting  upon  such 
a  condition  is  evident.  An  unconditional  acceptance 
would  bind  him  to  pay  at  maturity  even  if  the  shipping 
documents  were  not  present  to  be  offered  to  him  in  return 
for  payment.  Commercially  speaking,  he  might  be  com- 
pelled to  pay  for  his  goods  without  gaining  control  of  them. 
However  remote  this  possibility,  he  may  guard  himself 
against  it  by  employing  the  form  of  acceptance  above  re- 
ferred to.  Though  this  would  seem  reasonable  under  the 
circumstances,  the  acceptance  would  nevertheless  be  condi- 
tional.    In  our  letter  of  hypothecation,  the  drawer  assents 

12  Compare  §  12,  p.  30.  The  drawer  is  included  among  the  parties 
secondarily  liable,  even  if  there  has  been  no  acceptance.  See  again 
§  12. 


116  FOREIGN  EXCHANGE 

in  advance  to  a  conditional  acceptance  of  this  specific  char- 
acter. This  permits  the  banker  or  holder  of  the  bill  to 
take  this  kind  of  acceptance  without  losing  the  right  of 
recourse  on  the  drawer,  in  the  event  of  subsequent  dishonor 
by  non-payment. 

In  addition  to  the  bill  of  lading  and  the  documents  of 
insurance  and  hypothecation  already  discussed,  certain 
other  papers  often  accompany  documentary  drafts.  Usu- 
ally an  invoice,  or  bill  of  goods,  is  present,  giving  an 
itemized  statement  of  merchandise  shipped  with  prices  and 
charges.13  The  regulations  of  different  countries  governing 
import  duties  and  the  laws  pertaining  to  sanitation  make 
obligatory  the  taking  out  of  various  types  of  consular  cer- 
tificates by  persons  shipping  goods  into  these  countries. 
It  is  usually  necessary  or  convenient  for  these  certificates 
to  accompany  the  bill  of  lading  to  enable  the  goods  to 
be  entered  into  the  country  of  destination.  The  banker 
is  interested  in  having  all  such  documents  in  order,  for  if 
he  should  be  compelled  to  resort  to  the  merchandise  as 
collateral,  realization  upon  them  by  sale  might  be  much 
embarrassed  by  any  irregularity.  Furthermore  the  chances 
of  repudiation  of  a  trade  bill  by  the  drawee  might  be  in- 
creased by  failure  to  attend  to  the  requirements  which  must 
be  fulfilled  to  enable  him  to  come  at  the  goods  promptly. 

The  customs  regulations  of  the  United  States  provide 
that  "no  merchandise  exceeding  $100  in  value,  except 
personal  effects  accompanying  a  passenger,  shall  be  ad- 
mitted to  entry  without  the  production  of  a  certified  invoice 
thereof,  unless  the  importer  shall  make  application  under 

13  In  many  instances  the  invoice  may  be  contained  in  a  sealed 
envelope  addressed  to  tlie  purchaser,  to  avoid  publicity.  Margraff, 
"International  Exchange,"  p.  28.  The  invoice  per  se  is  of  course 
not  evidence  of  a  very  conclusive  character  for  the  banker  as  to  the 
value  of  the  merchandise  collateral.  The  reputation  of  the  shipper 
must  be  considered. 


THE  DOCUMENTARY  TRADE  BILL  117 

oath,  showing  that  it  is  impracticable  to  produce  such 
invoice.  .  .  ."  14  A  certified  invoice  is  obtained  by  the 
shipper's  presenting  his  invoice  to  an  American  consul 
at  or  near  the  place  of  shipment  and  signing  a  declaration 
that  the  document  is  in  all  respects  correct  and  true,  where- 
upon the  consul  certifies.15  Most  documentary  bills 
against  shipments  into  the  United  States,  whether  drawn 
on  the  United  States  or  drawn  under  a  bank  credit  on  some 
third  country  as  England,  will  have  certified  consular 
invoices  attached  at  least  at  first.10  17 

The  writer  is  informed  that  sometimes  the  drawee  of  a 
documentary  bill,  whether  the  importer  or  a  bank  secured 
by  him  to  serve  as  drawee,  stipulates  that  the  drawer  shall 
obtain  and  attach  to  the  draft,  a  certificate  of  inspection 
from  a  designated  third  party,  the  latter  being  appointed 
as  representative  of  the  buyer  to  see  that  the  goods  called 
for  by  the  agreement  of  sale  and  specified  in  the  invoice, 
are  actually  shipped  in  correct  quantity  and  quality. 

§  34.  The  documentary  instructions. — The  importer  who  is 
drawee  of  a  documentary  draft  has  the  right  in  any  event 
to  receive  the  attached  bill  of  lading  at  the  time  when  he 
pays  the  draft.  But  he  may  be  treated  more  liberally. 
The  bill  of  lading  may  be  handed  over  in  return  for  his 
mere    acceptance    of    the    draft.     The    disposition    of    the 

M  Article  202,  "Customs  Regulations  of  the  United  States,"  edi- 
tion of  1915,  Treasury  Department,  Division  of  Customs,  Washing- 
ton, D.  C.  Chapter  V  of  this  hook  of  733  pages,  contains  most  of 
the  regulations  pertaining  to  invoices. 

is  From  article  200  of  "Customs  Regulations,"  as  cited.  Detail 
in  the  nature  of  explanations  and  exceptions  may  he  found  in  this 
publication. 

is  Compare  the  instructions  pertaining  to  the  draft  which  appear 
in  the  specimen  commercial  letter  of  credit  to  he  found  on  p.  137 
helow. 

17  Considerable  information  on  the  suhject  of  documentary  secur- 
ity may  he  found  in  Margraff's  "International  Exchange,"  fourth 
edition,  1912. 


118  FOREIGN  EXCHANGE 

col  lateral  documents  is  governed  by  the  so-called  documen- 
tary instruct  ions,  which  oughl  always  to  be  determined 
upon  before  the  draft  is  drawn  and  sold.  These  instruc- 
tions may  be 

1.  Documents  for  payment  (D.P.) 

2.  Documents  for  acceptance  (D.A.) 

3.  Documents  for  delivery  (D.D.) 

The  last  is  rare.  It  would  confer  an  authority  to  surrender 
the  bill  of  lading  even  before  acceptance  takes  place.18 
Under  the  instructions  of  documents  for  acceptance  there 
will  be  a  period  running  from  the  time  of  acceptance  until 
the  time  of  payment,  typically  60  or  90  da}-s  in  length 
plus  any  days  of  grace,  during  which  the  holder  of  the  draft 
will  have  to  rely  exclusively  upon  the  personal  credit  of 
the  acceptor  and  the  parties  secondarily  liable.  Conse- 
quently the  instructions  documents  for  payment  give  the 
holder  the  greater  security,  preserving  his  interest  in  the 
collateral  till  the  end,  and  these  are  the  usual  instructions 
when  a  draft  is  drawn  on  an  ordinary  merchant.  When 
the  drawee  is  a  bank,  documents  for  payment  will  never 
be  the  instructions,  but  rather  documents  for  acceptance 
or  perhaps  documents  for  delivery.  When  a  bank  is 
drawee  documents  for  acceptance  would  be  understood  in 
the  absence  of  express  directions. 

A  draft  with  bill  of  lading  attached  governed  by  the 
instructions  of  documents  for  acceptance  is  called  in  brief 
a  "documentary  acceptance  bill."  Similarly  we  have  the 
'"'documentary  payment  bill."  As  said,  most  trade  bills 
are  documentary  payment  drafts,  nevertheless  when  the 
drawee  is  a  mercantile  house  of  excellent  standing  the  in- 

is  The  reader  bears  in  mind  that  most  foreign  documentary  drafts 
are  long  bills.  The  instructions  documents  for  acceptance  would 
not  be  in  point  in  the  case  of  a  documentary  sight  draft. 


THE  DOCUMENTARY  TRADE  BILL  119 

structions  may  be  documents  for  acceptance.  Against 
American  cotton  exports,  documentary  acceptance  bills  are 
drawn  in  great  numbers  upon  English  spinners.  The  clean 
acceptances  of  these  firms  sell  readily  in  the  London  dis- 
count market,  though  they  are  usually  subject  to  a  slightly 
higher  rate  of  discount  than  the  acceptances  of  bankers.19 
In  general  the  character  of  the  foreign  exchange  which 
arises  out  of  a  given  commercial  transaction  depends  on 
the  terms  and  understandings  of  the  sale.  These  may  in 
part  be  implied  from  the  usages  of  the  trade.  Thus  it  may 
be  understood  that  the  exporter  is  to  draw,  and  at  sixty 
days'  sight,  that  documents  are  to  be  attached,  and  that 
they  are  to  be  surrendered  only  against  payment  of  the 
draft.  The  instructions  to  govern  the  documents  are  as 
much  a  matter  for  adjustment  between  the  merchants,  as 
any  other  agreement  incidental  to  the  sale  of  the  goods. 
Misunderstandings  and  disputes  concerning  this  matter  are 
not  altogether  unknown.  When  the  drawer  offers  a  bill 
for  sale  to  a  banker,  the  documentary  instructions  will 
presumably  command  the  banker's  attention  before  he 
makes  the  purchase.  If  he  demands  that  they  be  documents 
for  payment,  it  is  incumbent  on  the  drawer  to  see  to  it 
that  his  arrangements  with  the  importer  permit  him  to 
create  a  bill  with  these  instructions. 

§  35.  Prepayment  and  the  retirement  rate  of  discount. — 
In  the  absence  of  a  special  reason,  we  would  hardly  expect 
the  acceptor  of  a  bill  to  come  forward  and  offer  to  discharge 
it  before  maturity.  But  it  is  very  common  indeed  for 
precisely  this  to  happen  in  the  case  of  documentary  pay- 
ment bills.  The  special  reason  is  not  hard  to  find.  The 
goods  against  which  a  term  bill  is  drawn  often  reach  their 
destination  long  before  the  bill  matures.     It  may  be  of  the 

i«  See  an  article  upon  "Financing  the  Cotton  Crop,"  by  Mr.  John 
J.  Arnold,  in  the  Annals  of  the  American  Academy  of  Political  and 
Social  Science,  September,  1911,  p.  290. 


L20  FOREIGN  EXCHANGE 

greatest  commercial  importance  to  the  importer  (drawee) 
to  secure  them  a1  an  earlier  date  than  this  maturity,  and 
where  they  are  of  a  perishable  nature  it  may  be  imperative. 
But  under  the  documentary  instructions  the  bill  of  lading 
and  merchandise  are  not  to  be  released  until  the  draft  is 
paid.  Suppose  A  of  New  York  sends  merchandise  to  B 
of  London,  the  price  of  which  is  £10,000,  it  being  under- 
stood that  A  is  to  draw  a  documentary  payment  bill  on  B 
for  this  amount  at  90  days'  sight.  A  ships  and  draws  on 
July  1st.  The  draft  is  sold  to  a  local  banker,  is  forwarded 
by  him  to  London  and  is  there  presented  to  B,  who  accepts 
perhaps  on  July  8th.  The  instrument  becomes  payable  93 
days  after  July  8th  (there  being  three  days  of  grace)  and 
so  matures  on  October  9th.  The  date  of  the  arrival  of 
the  goods  in  London  depends  on  the  manner  of  their  for- 
warding, but  they  might  easily  be  docked  say  by  July  15th. 
In  this  case  they  would  be  physically  available  86  days 
prior  to  the  maturity  of  the  draft.  If  we  suppose  now 
that  B  finds  it  necessary  to  obtain  these  goods  immediately, 
we  have  an  illustration  which  makes  clear  the  origin  of 
the  need  to  make  prepayment. 

The  question  perhaps  arises,  why  make  the  draft  run  at 
ninety  da}rs'  sight  under  these  circumstances?  Why  not 
draw  it  at  say  ten  days'  sight?  The  short  draft  is  some- 
times used,  but  its  employment  is  by  no  means  necessary. 
In  point  of  fact  the  importer  would,  other  things  remain- 
ing the  same,  prefer  to  be  drawn  upon  at  ninety  days  rather 
than  for  any  shorter  period  of  "usance."  We  shall  be  bet- 
ter prepared  to  see  why  this  is  the  case  after  we  have  looked 
further  into  the  system  of  prepayment  of  bills. 

Assuming  then  that  the  importer  has  need  to  obtain  his 
goods  on  July  15th,  the  instructions  being  "documents 
for  payment,"  he  can  procure  them  either  (1)  by  making 
a  prepayment  of  the  bill  on  that  date,  or  (2)  by  inducing 
the  bank  which  holds  the  draft  to  let  him  have  the  bill  of 


THE  DOCUMENTARY  TRADE  BILL  121 

lading  without  prepayment  despite  the  instructions.  There 
are  reasonable  arrangements  under  which  a  bank  might 
make  the  latter  concession  on  its  own  responsibility,20  but 
suppose  the  plan  of  action  is  prepayment.  Should  the 
drawee 's  offer  mean  prepayment  of  the  full  sum  due  on  the 
draft  at  its  maturity,  there  could,  of  course,  be  little  ques- 
tion in  practice  as  to  the  acquiescence  of  the  holder.  But 
the  drawee  will  hardly  expect  to  prepay  on  precisely  these 
terms.  He  will  request  that  an  allowance  be  made  him 
on  account  of  interest  for  the  .number  of  days  by  which 
his  payment  anticipates  the  date  of  maturity.  That  is, 
he  will  ask  for  what  is  sometimes  called  a  "rebate  of 
interest,"  and  thus  for  the  privilege  of  making  an  advanced 
retirement  of  the  bill  for  a  somewhat  lesser  sum  than  the 
full  amount  due  at  maturity.  If  he  discharges  the  draft 
say  86  days  before  it  is  due,  the  bank  which  has  held  it 
will  have  86  extra  days  "use"  of  the  money  paid  over. 
On  the  other  hand,  if  he  waited  till  maturity  to  pay,  he 
himself  would  have  86  more  days  use  of  this  amount  than 
if  he  makes  the  prepayment.  Money  being  "worth  its 
interest,"  it  is  the  custom  to  allow  the  drawee  a  "rebate 
of  interest"  for  payment  prior  to  maturity.  In  practice 
this  is  really  a  rebate  of  discount  rather  than  of  interest. 

In  the  case  of  ordinary  obligations,  no  right  of  prepay- 
ment with  a  concession  in  the  nature  of  a  rebate  of  in- 
terest, can  be  said  to  exist  in  law  or  custom.  But  in.  the 
single  case  of  the  documentary  payment  bill  of  exchange, 
there  is  a  customary  right  of  this  kind  of  great  importance 
and  long  standing.  Careful  search  by  the  present  writer 
has,  however,  failed  to  disclose  any  reference  to  this  matter 
in  the  statutory  law  of  England  or  of  the  United  States, 
and  the  right  seems  never  to  have  been  litigated  before  the 
courts  of  either  country.     Even  the  case  law  appears  to  be 

20  Compare  §  43  and  the  discussion  therein  of  the  "trust  receipt." 


L22  FOREIGN  EXCHANGE 

silent  on  the  subject.     If  the  search  has  not  been  faulty, 
this  is  a  singular  fact. 

The  right  of  prepayment  with  a  rebate  of  discount  being 
assumed,  the  question  becomes,  "At  what  rate  shall  this 
rebate  or  allowance  be  calculated?"  In  countries  upon 
which  documentary  payment  bills  are  drawn  in  large  and 
regular  volume,  there  is  a  public  and  so  to  say  standard 
(though  not  unvarying)  rate  employed  for  this  purpose. 
This  is  the  retirement  rate  of  discount,  called  also  the 
"rebate  rate"  and  again  the  "rebate  rate  of  interest,"  the 
last  designation  being,  strictly  speaking,  inaccurate.21  It 
will  be  found  to  be  a  rate  of  discount  in  all  cases.  Where 
prepayments  take  place  sporadically,  as  in  the  past  in  tht 
United  States  where  comparatively  speaking  few  docu 
mentary  payment  bills  have  been  domiciled,  the  rate  is  left 
to  private  and  individual  adjustment  between  the  drawee 
and  the  banker  holding  the  bill.  This  may  change  in  this 
country  in  the  near  future.  But  in  countries  where  pre- 
payment is  standardized  there  is  a  public  and  regular  rate. 
This  is  better  because  it  prevents  the  right  of  prepayment 
becoming  involved  in  disputes  as  to  the  rate  of  rebate  to  be 
allowed. 

To  give  a  formal  definition:  the  retirement  rate  of  dis- 
count is  the  rate  used  to  compute  the  sum  which  the  ac- 
ceptor of  a  "documentary  payment"  bill  must  pay  to  the 
holder  in  order  to  redeem  or  discharge  it  before  the  date 
of  its  maturity,  this  prepayment  having  as  its  purpose  the 
obtaining  of  the  bill  of  lading  attached  as  collateral.  The 
customary  retirement  rates  are: 

For  bills  payable  in  England. — One-half  of  1%  above  the  ad- 
vertised rate  of  interest  for  short  deposits  allowed  by  the  leading 
London  joint  stock  banks.     This  will  ordinarily  mean  that  the 

21  "Interest"  allowed  under  the  rehate  rate  can  be  called  such  only 
in  the  sense  of  "interest  in  advance,"  and  this  is  accurately  described 
as  discount.     Compare  §  17. 


THE  DOCUMENTARY  TRADE  BILL  123 

retirement  rate  is  1%  below  the  Bank  of  England's  Official  Mini- 
mum Discount  rate  (see  §  60  below). 

For  bills  payable  in  France,  Italy,  Belgium,  Germany. — 
The  same  as  the  minimum  rates  of  discount  of  the  national  or 
central  banks  of  these  countries. 

For  bills  payable  in  other  countries. — The  current  rate  of  rebate 
set  by  the  leading  banks  of  the  countries. 

In  Central  and  South  America,  and  in  north-west  and  east 
Africa,  the  rebate  rate,  according  to  Mr.  A.  J.  "Wolff,  is  agreed 
upon  by  the  drawer  and  drawee,  and  is  usually  6%  per  annum.22 

§  36.  The  actual  mercantile  receipts  for  and  costs  of  the 
goods. — The  price  quoted  in  an  international  transaction  is 
always  in  a  way  nominal,  at  least  for  one  of  the  parties, 
if  not  for  both.  In  our  most  recent  illustration,  £10,000 
was  the  price  of  the  goods,  but  it  was  neither  the  exact 
figure  paid  for  them  by  the  importer  nor  the  amount  re- 
ceived by  the  exporter.  The  latter,  in  fact,  took  in  dollars 
and  not  pounds  at  all.  In  explaining  the  simple  calcula- 
tions required  to  find  true  costs  to  importers  and  returns 
to  exporters,  we  shall  ignore  the  less  usual  instances  of 
the  quotation  of  price  in  the  money  of  a  third  country, 
and  consider  only  the  twro  cases  of  quotation  in  the  money, 
first,  of  the  importer's  country,  and  second,  of  the  ex- 
porter's country.  Let  us  now  continue  with  the  illustration 
set  forth  in  the  preceding  section.  On  July  1st,  A  made  a 
shipment  to  and  drew  upon  B,  the  draft  being  for  £10,000 
and  at  90  days'  sight.  The  goods  arrived  on  July  1 5th  and 
B  prepaid  the  draft  on  that  date.  The  sum  paid  over  to 
retire  this  bill  is  the  first  cost  of  the  goods  to  B.  If  any 
charges  were  left  for  B  to  pay  they  would  have  to  be  added. 
The  face  value  of  the  bill  being  £10,000  (or  the  price  of  the 
goods),  the  amount  required  to  prepay  it  will  depend  mi  the 

22  See  "Foreign  Credits,"  by  A.  J.  Wolff,  Special  Agent's  Series, 
No.  62,  U.  S.  Department  of  Commerce  and  Labor,  Washington, 
1913,  p.  29. 


124  FOREIGN  EXCHANGE 

current  retirement  rate  of  discount.     Supposing  the  Bank  t 
Rate  to  stand  at  412%  and  the  deposit  allowance  rate  of 

the  joint  stock  banks  therefore  to  be  3%,  the  retirement  | 

rate  will  be  31/£%.     Since  retirement  takes  place  86  days  I 

prior  to  maturity,  the  amount  payable  to   discharge  the  ] 
bill  is  computed  as  follows: 

Face  or  maturity  value  of  the  draft £10,000.00 

Rebate   of   discount,   for   86   days   at   3}&%    per 

annum     82.47 

(8%65><3%%  of  10,000) 

Amount  required  for  prepayment  of  draft £  9,917.53 

Or  9,917  pounds,  10  shillings  and  7  pence. 

A's  returns  from  his  export  consist  simply  in  the  amount 
received  by  him  from  the  sale  of  the  draft  for  £10,000  to 
a  local  banker,  and  this  depends  on  the  current  rate  of 
exchange  for  the  type  of  bill  A  has  to  offer.  (If  the  draft 
were  deposited  for  collection  instead  of  being  sold,  A's 
return  will  be  the  net  proceeds  of  the  collection,  when  these 
proceeds  come  to  hand,  and  these  will  be  governed  to  a  small 
extent  by  commission  charges  but  principally  by  the  future 
position  of  a  rate  of  exchange,  whether  it  be  a  rate  in  New 
York  on  London  or  one  in  London  on  New  York.)  A 
banker's  buying  rate  for  A's  draft  will  hinge  on  factors 
to  be  discussed  at  a  later  point  in  this  book.  Let  us  sup- 
pose it  to  be  4.81.     A's  returns  are  then  simply  $48,100. 

Draft  for  £10,000  sold  at  4.81  per  pound $48,100 

If  we  change  the  length  of  life  of  the  draft  from  90  to 
60  days,  while  assuming  all  other  independent  factors  un- 
changed, we  shall  find  that  the  goods  will  cost  the  importer 
something  more  than  before  and  pay  the  exporter  something 
more.  The  cost  to  the  importer  will  be  increased  because 
the  date  of  the  maturity  has  been  shifted  30  days  nearer  to 


THE  DOCUMENTARY  TRADE  BILL  125 

the  day  of  retirement,  and  there  will  consequently  be  30 
days  less  time  for  which  the  rebate  of  discount  is  allowable. 
The  draft  would  mature  63  days  after  July  8th,  or  on 
September  9th.  Being  prepaid  on  July  15th,  it  has  at  the 
time  56  instead  of  86  days  to  run.  The  first  cost  of  the 
goods  to  the  importer  will  therefore  be  £9946.3,  found  as 
follows : 

Face  or  maturity  value  of  the  draft £10,000. 

Rebate   of   discount,    for   56    days   at   3^%    per 

annum    53.7 

(B%esX3^%  of  10,000) 

Amount  required  for  prepayment  of  draft £  9,946.3 

With  the  supposed  reduction  of  the  length  of  life  of 
the  draft,  exporter  A  will  obtain  increased  returns  be- 
cause he  will  be  able  to  sell  a  sixty  days'  sight  draft  at  a 
somewhat  higher  rate  than  one  at  ninety  days'  sight.  We 
assumed  a  rate  of  4.81  for  the  longer  draft.  Let  us  assume 
roughly  the  rate  of  4.8240  for  the  shorter  one  under  the 
same  conditions.  The  rate  will  be  higher  precisely  because 
the  shorter  draft  will  be  subject,  to  a  lesser  discount  if  pre- 
paid abroad  or,  at  any  rate,  will  yield  its  full  maturity 
value  at  an  earlier  date  than  would  the  longer  bill  if  there 
is  no  prepayment.  A's  returns  in  the  new  case  will  be 
simply  $48,240,  calculated  thus : 

Draft  for  £10,000  sold  at  4.8240  per  pound $48,240 

If  we  compare  the  results  from  the  employment  of  the 
two  different  drafts,  we  obtain  the  following : 

Cost  to  Importer     Returns  to  Exporter 

Draft  at  sixty  days £9,946.3     $48,2  10 

Draft  at  ninety  days 9,917.53   48,100 


Result  of  shorter  term.  .  .  .£      28.77  increase,     $      140  increase. 


126  FOREIGN  EXCHANGE 

Thus  to  reduce  the  length  of  the  draft  is  tantamount  to 
raising  the  price.  In  general,  of  course,  an  importer  who 
agrees  to  submit  to  a  shorter  draft  rather  than  a  longer 
one,  will  expect  and  receive  a  price  quotation  lowered  about 
enough  to  compensate  for  the  change.  The  exact  reduction 
in  price  which  would  be  necessary  to  effect  this  compensa- 
tion could  always  be  calculated  if  the  governing  discount 
factor  is  known. 

In  the  fourth  paragraph  of  the  letter  of  hypothecation 
which  was  shown  in  §  33,  the  drawer  of  the  bill  gives  assent 
to  any  plan  of  partial  deliveries  of  the  goods  to  the  drawee, 
to  which  the  bank  or  holder  may  care  to  agree,  provided 
the  drawee  makes  prepayments  of  proportionate  amounts 
on  account  of  the  bill.  The  privilege  of  taking  out  partial 
deliveries  might  be  of  great  convenience  to  the  drawee.  If 
he  should  have  immediate  need  for  say  only  a  fifth  of  the 
consignment  at  the  time  of  its  arrival,  it  would  be  necessary 
to  find  only  sufficient  present  cash  to  prepay  a  fifth  part 
of  the  draft.  Suppose  then  that  importer  B  finds  it  de- 
sirable to  take  out  a  fifth  of  the  goods  on  July  15th,  and 
one-half  on  August  20th,  and  the  remainder  on  August 
30th.  The  schedule  beneath  will  show  the  payments  on 
account  required,  and  the  manner  of  their  calculation. 


Propor- 

tionate 

amount 

Days  by 

of   face 

Current 

which 

Portion 

value  of 

retire- 

prepayment 

of  goods 

£10,000 

ment 

anticipates  Rebate  of 

Amount  of 

Date 

taken 

draft 

rate 

maturity      discount 

prepayments 

July 

15 

One-fifth 

£2,000 

3%% 

86               £16.49 

£1,983.51 

Aug. 

20 

One-half 

£5,000 

3% 

50               £20.55 

£4.979.45 

Aug. 

30 

Three-tenths 

£3,000 

4% 

40               £13.15 

£2,986.85 

The  three  prepayments  effect  a  complete  discharge  of  the 
debt.  It  will  suffice  to  explain  the  method  of  calculating 
any  one  of  them.  Take  the  second.  On  August  20th  the 
importer  desires  to  obtain  one-half  of  the  total  quantity 
of  goods  shipped.     He  will  therefore  be  required  to  prepay 


THE  DOCUMENTARY  TRADE  BILL  127 

one-half  of  the  total  face  value  of  the  draft,  or  £5,000. 
On  this  date  the  retirement  rate  happens  to  be  3%,  and 
the  particular  prepayment  takes  place  50  days  before  the 
due  date  of  the  instrument.  Therefore  the  rebate  of  dis- 
count for  this  prepayment  will  be  5%65  of  3%  of  £5,000, 
or  £20.55 ;  and  the  required  prepayment  will  be  5,000  less 
20.55,  or  £4979.45. 

It  remains  now  to  calculate  the  mercantile  costs  and  pro- 
ceeds of  the  export  in  the  case  where  the  exporter's  price 
is  quoted  in  the  money  of  his  own  country.  Suppose,  then, 
that  in  this  same  export  the  price  is  quoted  as  $48,200. 
As  before,  let  a  90  days'  sight  documentary  payment  draft 
be  drawn  upon  B,  the  importer.  Under  the  new  supposi- 
tion everything  will  be  as  before  except  that  the  number 
of  pounds  of  face  value  of  the  draft  will  not  be  exactly 
predetermined.  The  new  arrangement  will  mean  that  A  is 
to  draw  for  a  .sufficient  number  of  pounds  to  enable  him  to 
sell  the  draft  for  $48,200,  at  the  existing  rate  of  exchange. 
At  the  time  the  price  in  dollars  is  quoted  this  rate  of  ex- 
change will  not  be  precisely  foreknown.  Suppose  that 
when  the  shipment  is  made  and  the  draft  is  ready  for  sale, 
it  turns  out  to  be  4.801/2.  The  size  of  the  draft  to  be  drawn 
by  A  would  then  be  computed  as  follows : 

4.805)48200.000(10031.22 
4805 


15000 

14415 

5850 
4805 

10450 
9G10 

8400 
9G10 
For  each  pound  of  draft  sold  A  receives  $4,805.     48,200 


L28  FOR  EI  ON  KXCIIAXGF, 

contains  4,805,  10031.22  times.  Therefore  10031.22  pounds 
of  draft  would  have  to  be  drawn  and  sold.  This  is  other- 
wise expressed  £10031.  4s.  5d.  In  the  present  case,  the 
importer  takes  what  is  called  the  "risk  of  exchange"  for 
the  number  of  pounds  of  draft  which  he  will  have  to  pay 
will  vary  according  to  the  position  of  the  rate  of  exchange 
at  the  time  when  the  shipment  is  made.  As  our  illustration 
has  turned  out,  his  taking  this  risk  makes  the  goods  cost 
him  £31.22  more  than  before.  In  the  earlier  case  the  ex- 
porter took  the  risk  of  exchange,  because  the  number  of 
dollars  return  that  he  would  receive  was  not  precisely  fixed 
in  advance  but  depended  on  the  rate  at  which  he  could 
sell  the  draft  for  the  fixed  amount  in  pounds  agreed  upon. 
In  connection  with  the  subject  of  prepayment,  the  ques- 
tion doubtless  suggests  itself,  why  not  draw  documentary 
payment  drafts  ' '  payable  on  the  date  of  arrival  of  the  mer- 
chandise covered  by  the  attached  bill  of  lading."  The 
writer  has  been  given  to  understand  that  drafts  of  this 
tenor  are  not  unknown,  but  they  are  open  to  two  objections. 
In  the  first  place,  an  instrument  drawn  in  this  manner 
would  not  be  negotiable.  It  would  be  transferable,  but  it 
would  fail  of  negotiability  in  the  peculiar  legal  sense  ex- 
plained in  §  9  of  this  book.  The  reason  is  because  it  is 
not  made  payable  at  what  the  law  regards  as  a  fixed  or 
determinable  future  time  (compare  the  definitions  of  ne- 
gotiable bills  and  notes  as  given  on  pages  11  and  18 ).23 
A  determinable  future  time  does  not  mean  one  that  is  neces- 
sarily predeterminable  at  every  stage  of  the  instrument's 

23  "An  instrument  payable  upon  a  contingency  is  not  negotiable, 
and  the  happening  of  the  event  does  not  cure  the  defect."  Uniform 
Law  as  already  cited,  §  23.  If  an  instrument  is  to  be  negotiable, 
it  must,  as  regards  the  time  of  payment,  be  payable  either  ( 1 )  on 
some  definite  date  specified  in  the  instrument  or  on  a  day  a  desig- 
nated period  before  or  after  a  designated  date,  or  (2)  on  demand 
or  at  sight,  or  (3)  at  the  end  of  a  specified  period  after  demand  or 
sight,   or    (4)    on,  or   at   a  fixed  period   after,   the  occurrence  of   a 


THE  DOCUMENTARY  TRADE  BILL  129 

existence,  but  one  which  is  certain  to  come  and  which  is 
precisely  determinable  (and  not  indefinite)  when  it  does 
come.  A  draft  payable  on  the  date  of  arrival  of  a  desig- 
nated consignment  of  merchandise  is  not  payable  at  a  time 
which  is  certain  to  come.  The  merchandise  might  be  lost 
and  never  arrive.  It  is  eminently  desirable  from  the  stand- 
point of  a  purchaser  that  a  bill  should  be  truly  negotiable  in 
form,  and  therefore  bills  paj'able  on  the  arrival  of  merchan- 
dise suffer  from  a  fundamental  defect.24  There  is  a  second 
obvious  objection  to  this  style  of  draft,  although  it  is  an 
objection  from  the  importer's  standpoint  only,  because  the 
instrument  deprives  the  importer  of  the  valuable  and  con- 
venient option  which  he  ordinarily  has  of  taking  out  the 
goods  and  paying  for  them  at  any  time  selected  by  himself 
within  a  considerable  period. 

The  documentary  sight  draft  is  not  unknown  to  foreign 
trade  but  its  use  deprives  the  importer  of  the  option  just 
mentioned,  or  to  make  virtually  the  same  point,  this  draft 
without  supplementary  agencies  furnishes  no  means  of  shift- 
ing the  burden  of  financing  the  merchandise  movement 
to  the  bank  or  money  lender.  With  regard  to  the  em- 
ployment of  time  bills,  but  bills  of  short  usance,  a  news 
item  in  the  Wall  Street  Journal  (of  New  York)  for  May 
21,  1913,  page  8  (article  on  "Money")  is  of  interest.  It 
explains  that  at  the  time  the  North  American  Grain  Ex- 
porters' Association  had  just  induced  the  representatives 
of  the  British  grain  trade  to  agree  to  pay  for  grain  ship- 
ments thereafter  by  submitting  to  seven  days'  instead  of 
sixty  days'  sight  drafts.  To  quote,  "the  origin  of  the  prac- 
tice of  drawing  bills  at  sixty  days'  sight  against  grain 
shipments  dates  back  to  the  days  when  it  took  a  grain- 
specified  event,  which  is  certain  to  happen,  though  the  time  of 
happening  may  be  uncertain  beforehand. 

2*  Special  incidental  contracts  might,  however,  be  employed  to 
preserve  the  rights  of  recourse  on  indorsees   (if  any)   and  the  drawer. 


L30  FOREIGN   EXCHANGE 

bearing  vessel  nearly  two  months  to  cross  the  ocean.  Nowa- 
days,  however,  grain  is  carried  in  fast-moving  steamers, 
which  reach  their  desl inal ion  in  less  than  ten  days.  In 
other  wonls.  the  cargo  arrives  practically  at  the  same  time 
thai  the  bill  covering  it  arrives  and  is  accepted."  But 
rapid  transportation  is  not  likely  to  change  the  general 
custom  of  drawing  documentary  payment  bills  at  sixty  and 
ninety  days'  sight  against  a  great  variety  of  types  of  ex- 
ports, because  the  drawing  of  bills  of  this  kind  coupled 
with  the  privilege  of  prepayment,  seems  on  the  whole  the 
most  suitable  among  all  methods  of  settlement  by  draft  on 
the  importer  in  person  as  drawee. 

The  drawee  may  obtain  the  funds  with  which  to  make 
prepayment  of  a  documentary  draft,  by  borrowing  from 
some  bank  against  the  collateral  of  the  very  goods  covered 
by  the  draft,  for  as  soon  as  the  draft  is  retired  the  goods 
are  released  and  become  available  as  security  for  the  new 
loan.  A  loan  of  this  character  would  be  much  like  any 
other  loan  on  merchandise  collateral  or  against  warehouse 
receipts,  and  the  detail  of  its  terms  and  the  subsequent 
handling  of  the  goods  would  depend  upon  the  local  customs 
and  circumstances  affecting  such  arrangements. 


CHAPTER  VII 
THE  BANK  CREDIT  AND  LETTER  OF  CREDIT 

§  37.  The  nature  of  the  commercial  credit. — The  purpose 
of  a  commercial  letter  of  credit  is  to  enable  an  exporter 
to  draw  his  draft  upon  a  bank  instead  of  upon  the  im- 
porter. Before  proceeding  we  had  better  recapitulate.  An 
exporter  may  obtain  payment  (1)  by  receiving  a  remittance 
of  exchange  (whether  directly  or  through  some  bank)  or 
(2)  by  himself  drawing  exchange.  If  the  exporter  draws, 
the  drawee  may  be  either  (a)  the  importer  or  (b)  some 
bank  which  has  been  induced  to  serve  in  his  stead.  Where 
the  importer  is  the  drawee,  we  have  the  trade  bill,  which 
has  been  considered  in  the  chapter  just  brought  to  a  close. 
We  come  now  to  the  case  of  the  merchant's  draft  on  a 
bank.  The  right  of  a  merchant  to  draw  upon  a  bank  on 
account  of  an  export  is  known  as  a  "commercial  credit" 
and  also  as  a  "bank  credit."  The  commercial  letter  of 
credit  is  the  instrument  or  document  which  bears  witness 
to,  or  affirms  the  existence  of  the  bank  credit.  It  com- 
monly takes  the  form  of  a  letter  of  information  and  au- 
thorization addressed  to  the  merchant  who  is  empowered 
to  draw,  and  hence  its  name.  There  is  one  other  kind  of 
letter  of  credit,  having  a  certain  degree  of  importance  in 
exchange  dealings,  known  as  the  traveler's  or  the  circular 
letter  of  credit.     Of  this  we  shall  speak  later. 

A  description  of  the  uses  of  the  bank  credit  in  inter- 
national trade  under  the  conditions  existing  before  the 
present  European  conflict,  would  necessarily  be  very  largely 
a    story    of    sterling    exchange.     Although    the    war    has 

131 


132  FOREIGN   KXCIIANGE 

broughl  sonic  important  modifications  into  the  exchange 
methods  of  the  world,  and  although  certain  of  these  will 
probably  persisl  when  peaceful  commerce  is  resumed,  the 
besl  way  at  present  writing,  and  the  way  we  shall  follow, 
to  explain  the  system  of  bank  credits  is  to  deal  with  it 
as  it  was  before  the  war  broke  forth,  resorting  to  concrete 
illustrations  that  would  be  typical  then.  A  very  great  part 
of  llic  system  will  almost  certainly  endure,  and  such  changes 
as  establish  themselves  will  be  primarily  alterations  in 
concrete  detail,  which  will  leave  the  general  scheme  ex- 
plicable  on  the  same  lines  of  argument  as  before.  When 
we  shall  find  New  York  banks  accepting  drafts  both  drawn 
abroad  and  authorized  by  banks  foreign  to  the  United 
States,  we  shall  be  confronted  with  nothing  new  in  the  way 
of  general  system.  Illustrations  founded  on  ante-bellum 
conditions  will  need  to  be  altered  only  by  changing  the 
nationality  of  the  banks  involved. 

The  simplest  instance  of  the  commercial  letter  of  credit 
is  the  case  where  the  bank  which  writes  it  gives  an  author- 
ization for  drafts  to  be  drawn  upon  itself.  A  slightly  more 
complex  case  is  one  where  the  writer  authorizes  the  draw- 
ing of  drafts  on  a  bank  distinct  from  itself  and  located 
in  a  different  country.  To  illustrate  the  simpler  case  first, 
suppose  an  English  importer  of  goods  from  the  United 
States,  obtains  from  a  London  bank  a  credit  in  favor  of 
the  American  exporter.  To  do  this  he  will  enter  into 
certain  agreements  with  the  bank  the  general  character 
of  which  we  shall  consider  later.  The  bank  will  write 
a  letter  of  credit,  addressed  to  the  American,  which  it 
may  however  hand  over  to  the  English  merchant  for  for- 
warding. Assume  the  goods  to  be  sold  for  a  price  named  in 
pounds  sterling.  As  the  American  makes  the  appointed 
shipment  he  draws  a  documentary  draft  for  the  number  of 
pounds  the  consignment  is  worth  at  the  price  agreed  upon, 
and  makes  the  draft  run  for  the  number  of  days'  sight 


THE  BANK  CREDIT  AND  LETTER  OF  CREDIT      133 

provided  for  in  the  letter,  usually  sixty  or  ninety.  He 
makes  the  London  bank  the  drawee.  Armed  with  the  letter 
of  credit  as  his  credentials,  he  approaches  a  local  American 
bank  with  an  offer  of  the  draft  for  sale.  Taking  it  for 
granted  this  bank  is  certain  of  the  genuineness  of  the 
letter  and  of  the  correctness  of  the  documents  and  draft, 
it  will  stand  ready  to  buy  at  a  higher  rate  than  if  the  draft 
were  drawn  merely  upon  the  English  importer  himself  as 
a  private  person.  Perhaps  in  the  latter  case  it  would  be 
t  willing  to  take  the  draft  only  for  collection.  Stated  simply, 
the  advantage  of  the  bank  credit  to  the  exporter  is  that  it 
gives  great  assurance  of  the  salability  of  his  draft  and  this 
at  a  favorable  rate.  The  purchasing  bank  knows  that 
when  the  draft  reaches  London  and  is  accepted  according 
to  agreement  by  the  drawee  bank,  it  will  become  an  ex- 
emplar of  the  highest  class  of  paper  in  that  money  capital. 
It  will  become  the  unconditional  obligation  of  a  London 
bank.  The  fact  that  the  drawer,  as  a  party  secondarily 
liable,  is  a  mere  merchant  will  make  little  or  no  difference. 
This  acceptance  will  be  discountable  in  London  at  the  lowest 
market  rates  and  will  have  the  highest  present  value  in 
pounds  after  its  arrival.  For  these  reasons  it  is  a  good 
purchase  on  this  side  of  the  water  and  a  relatively  high 
price  can  be  paid  for  it. 

§  38.  The  grant  by  one  bank  of  the  right  to  draw  on 
another  bank. — Our  last  illustration  has  shown  in  brief 
how  an  English  importer  might  provide  for  settlement 
by  arranging  for  a  bank  credit  in  favor  of  his  foreign 
creditor  to  be,  namely  the  exporter.  An  importer  in  prac- 
tically any  country  in  the  world  may  also  take  out  a  bank 
credit  for  the  same  purpose.  Suppose  an  American  makes 
application  to  one  of  our  banks  for  a  credit  in  favor  of 
an  Italian  house  which  is  about  to  make  him  a  shipment. 
If  this  bank  issues  a  letter  authorizing  drafts  upon  itself, 
the  plan  of  settlement  is  as  a  matter  of  system   identical 


134  FOREIGN  EXCHANGE 

wit  1 1  thai  of  the  preceding  illustration.  In  this  instance 
we  have  an  American  bank  providing  for  an  American 
importation  by  authorizing  a  draft  on  itself  payable  in 
American  dollars,  while  in  the  former  case  we  had  simpjy 
an  English  bank  providing  for  an  English  importation 
by  authorizing  a  draft  on  itself  payable  in  English  pounds. 
Bui  under  ante-bellum  conditions,  and  these  were  condi- 
tions that  had  persisted  for  a  long  period  and  ha$  become 
normalized,  neither  the  banks  in  the  United  States  nor 
those  in  most  countries  other  than  England  did  much 
business  in  credits  permitting  time  drafts  upon  them- 
selves.1 Instead  they  issued  in  the  great  majority  of  cases 
what  are  called  "sterling  credits."  These  comprise  any 
credits  under  which  the  beneficiaries  are  empowered  to 
draw  drafts  in  pounds  on  English  banks,  whether  the 
authorization  issues  from  the  English  banks  themselves  or 
with  their  permission  from  banks  in  other  countries.  There 
are  also  similar  and  self-explanatory  terms  such  as  "dollar 
credits,"  "franc  credits,"  and  so  on.  Before  the  war 
American  banks  were  driving  a  large  and  ever-increasing 
traffic  with  our  importers  in  commercial  credits,  as  we 
call  them,  but  the  vastly  preponderating  part  of  these 
were  sterling  credits.  A  few  were  franc  or  mark  credits, 
while  almost  none  were  dollar  credits.  French  and  Ger- 
man banks  were,  however,  issuing  a  certain  volume  of 
credits  upon  themselves.  During  the  progress  of  the  war 
our  banks  began  the  issue  of  dollar  credits,  in  noticeable 

i  It  is  the  generally  accepted  opinion  that  prior  to  the  enactment 
of  the  recent  banking  reform  laws,  national  banks  in  the  United 
States  (or  those  chartered  by  the  Federal  government)  did  not  have 
the  legal  power  to  submit  to  or  accept  time  drafts.  However,  this 
question  had  not  been  passed  upon  by  the  Supreme  Court  of  the 
United  States.  In  any  event  it  may  safely  be  said  this  mere  legal 
disability  of  our  leading  class  of  banks  had  little  or  nothing  to  do 
with  the  failure  up  to  that  time  of  the  acceptance  business  to 
develop  in  this  country.  , 


THE  BANK  CREDIT  AND  LETTER  OF  CREDIT      135 

volume  for  the  first  time  in  our  history.  The  extensive  and 
permanent  use  of  the  dollar  draft  in  Latin-American  coun- 
tries in  connection  with  commerce  to  and  from  the  United 
States  seems  now  assured  (1919),  and  it  is  quite  possible  the 
sterling  draft  will  never  regain  its  ante-bellum  importance 
in  relation  to  this  commerce. 

The  authority  under  which  an  American  bank,  or  any 
other  non-English  bank,  issues  a  sterling  credit,  is  derived 
from  the  grant  to  it  by  an  English  correspondent  bank 
of  a  so-called  "acceptance  account,"  of  which  we  shall 
speak  in  more  detail  later.2  It  appears  then  that  a  sterling 
credit  may  originate  in  two  ways:  it  may  be  issued  (1) 
by  an  English  bank  upon  itself,  or  (2)  by  some  foreign 
correspondent  of  an  English  bank,  or  by  an  outlying  branch 
bank  upon  a  London  office.  If  it  is  written  by  an  English 
bank  itself  we  may  assume  it  is  to  finance  an  import  into 
Great  Britain.  But  if  issued  by  a  bank  in  some  country 
other  than  England,  it  may  be,  and  in  fact  more  frequently 
is,  connected  with  a  movement  of  merchandise  which  neither 
goes  to  nor  comes  from  England.  To  make  a  statement 
general  in  form,  an  export  of  goods  from  country  B  to 
country  C  may  be  settled  for  by  means  of  a  credit  on 
country  A  issued  in  country  C.  The  country  A  par  ex- 
cellence of  the  world  has  been  England.  An  import  by 
Italy  from  the  United  States,  or  an  import  by  the  United 
States  from  Italy,  or  a  shipment  of  goods  between  almost 
any  two  countries  in  the  world,  may  give  rise  to  a  sterling 
credit  which  will  be  issued  by  a  bank  in  the  importing 
country.  This  is  the  fact  which  lies  at  the  basis  of  such 
statements  as  that  the  commerce  of  the  world  is  settled 
"through"  London.  Mr.  H.  K.  Brooks  says  in  his  "For- 
eign Exchange  Text-Book"   (dated  1906)   that  "probably 

2  This  account  may  serve  also  as  the  basis  of  the  drawing  of  so- 
called  "finance  bills,"  an  operation  of  distinct  character.  Compare 
Chapter  XII. 


i:;ii  FOREIGN   EXCHANGE 

ninety  per  cent,  of  all  letters  of  credit  issued  throughout 
the  world  are  drawn  in  English  money"  (page  7).  This 
signifies  doI  thai  ninety  per  cent,  of  the  world's  commerce 
•tied  through  London,  but  merely  that  ninety  per  cent. 
of  the  commercial  and  travelers'  letters  of  credit  are  for 
sterling,  in  the  next  section  we  shall  begin  the  serious 
development  of  the  subject  of  the  bank  credit  by  presenting 
an  illustration  of  the  settlement  of  an  export  from  Italy 
to  the  United  States  by  means  of  a  credit  in  London. 

§  39.  How  merchants  make  use  of  commercial  credits. — 
Let  it  be  supposed  a  Chicago  firm  arranges  to  import  a 
consignment  of  olive  oil  from  Italy.  The  price  at  which 
the  Italian  agrees  to  sell  may  conceivably  be  expressed 
in  lire,  the  money  of  Italy,  or  in  dollars,  the  money  of 
the  United  States,  or  in  pounds  sterling,  the  money  of 
England  ;  not  to  speak  of  the  possibility  of  a  price  in  francs 
or  marks,  the  money  of  some  third  country  other  than 
England.  But  the  general  practice  in  the  case  of  exports 
into  the  United  States  is  for  the  exporter  to  name  his  price 
in  the  currency  of  his  own  country,  and  in  this  illustration 
we  shall  assume  that  the  price  is  set  in  lire.  The  Ameri- 
can, the  importer,  explains  the  proposed  transaction  to 
his  bank  and  procures  from  it  a  sterling  letter  of  credit 
in  favor  of  the  Italian  house,  upon  terms  to  be  considered 
presently.     Beneath  is  a  specimen  of  such  a  letter. 

Xo.  G.  C.  0000  Capital,  $10,000,000.00 

£1,000.  *  *  *  Surplus,  $10,000,000.00 

The  Hundredth  National  Bank  op  Chicago 

Chicago,  July  1st,  1913. 
The  Italian  Olive  Oil  Export  Co. 

Genoa,  Italy. 
Gentlemen : 

We  hereby  authorize  you  to  value  on  the  London  Joint  City 
and  Midland  Bank,  Ld.,  Threadneedle  Street,  London,  at  sixty 
days'  sight  for  any  sum  or  sums  not  exceeding  in  all  one  thou- 


THE  BANK  CREDIT  AND  LETTER  OF  CREDIT      137 

sand  pounds  sterling  for  account  of  The  American  Import  Co. 
for  invoice  cost  of  olive  oil  to  be  shipped  to  The  American  Im- 
port Co.,  Chicago,  U.  S.  A. 

The  Bills  of  Lading  must  be  issued  to  the  order  of  shipper 
and  indorsed  in  blank. 

The  Shipment  must  be  completed  and  the  Bill  drawn  on  or 
before  December  31st,  1913,  and  the  advice  thereof  (in  dupli- 
cate) sent  to  The  London  Joint  City  and  Midland  Bank,  Ld., 
London,  accompanied  by  Bill  of  Lading  and  abstract  of  Invoice, 
on  receipt  of  which  Documents  the  Bills  will  be  duly  honored. 

The  remaining  Bills  of  Lading  with  certified  Invoices  and 
Consular  Certificates  must  be  sent  by  the  Bank  or  Banker  nego- 
tiating drafts  to  The  New  York  Customs  Brokers  Co.,  New  York, 
U.  S.  A.,  for  account  of  The  Hundredth  National  Bank  of  Chi- 
cago, and  a  certificate  to  that  effect  must  accompany  draft. 

We  hereby  agree  with  drawers,  endorsers  and  bona  fide  hold- 
ers of  drafts  drawn  under  and  in  compliance  with  the  terms  of 
this  credit  that  the  same  shall  be  duly  honored  upon  presentation 
at  the  counter  of  The  London  Joint  City  and  Midland  Bank,  Ld., 
London. 

Drafts  under  this  Credit  must  bear  upon  their  face  the  words : 
Drawn  Under  The  Hundredth  National  Bank  op  Chicago 
Credit  No.  G.  C.  0000.    Dated  July  1,  1913. 

Respectfully  yours, 

»         #         •         • 

Manager  of  Foreign  Exchange  Department. 

This  instrument  may  be  divided  into  three  parts.  (1) 
In  the  first,  it  confers  upon  the  party  in  whose  favor  it 
runs  (in  this  case  the  party  to  whom  it  is  addressed),  an 
authority  to  draw  upon  a  given  bank  on  account  of  a 
specified  commercial  transaction  or  set  of  transactions. 
(2)  In  the  second,  it  lays  down  certain  requirements  re- 
garding the  manner  of  use  of  the  credit  so  conferred.  It 
prescribes  the  kind  (as  documentary)  and  length  of  life 
of  the  draft  or  drafts,  and  makes  clear  that  no  draft  is 
to  exceed  in  value  the  invoice  cost3  of  the  shipment  against 

'■>  The   authorization    to    "value"    on    the    London    Joint    City    and 


FOREIGN  EXCHANGE 

which  it  is  drawn.  It  states  the  limit  beyond  which  the 
total  of  all  drafts  musl  aol  ascend,  iii  this  instance  £1,000. 
It  demands  the  presence  of  certain  documents,  such  as  the 
certified  invoice,  and  provides  for  the  disposition  of  the 
documents.  It  gives  the  date  of  expiry  of  the  credit,  after 
which  oo  shipments  may  be  made  and  drafts  drawn  under 
it.*  (3)  The  third  part  of  the  letter  contains  the  engage- 
ment of  the  writer  bank  that  all  drafts  drawn  under  it 
and  in  compliance  with  its  terms  shall  be  duly  honored. 
The  Italian  Olive  Oil  Export  Company  is  the  beneficiary: 
the  American  Import  Company  is  the  party  for  whose 
account  the  letter  is  issued.  The  instructions  that  the 
bills  of  lading  are  to  be  made  out  to  the  order  of  the  shipper 
and  indorsed  by  him  in  blank,  have  the  same  significance 
here  as  in  the  case  of  the  documentary  trade  bill  (compare 
§  31).  Sometimes  the  shipper  is  directed  to  have  the  bills 
of  lading  made  out  to  the  order  of  the  bank  itself,  that 
is,  to  the  order  of  the  bank  which  writes  the  letter  of 
credit,  this  being  the  institution  that  takes  the  credit  risks 
and  the  one  that  is  in  any  case  to  have  the  claim  upon  the 
merchandise  as  collateral  security. 

One  copy  of  the  bill  of  lading  is  to  remain  attached  to 
the  draft  until  the  latter  is  presented  to  the  drawee  bank 
for  acceptance.  This  copy  serves  to  show  the  accepting 
bank  that  the  goods  have  been  shipped  and  the  draft  is 
in  proper  order.  In  the  case  of  all  drafts  drawn  on  banks 
the  instructions  are  documents  for  acceptance,  whether 
these  instructions  are  expressed  or  implied;  and  upon  ac- 

Midland  Bank  "for  invoice  cost  of  olive  oil  to  be  shipped"  etc.,  means 
a  power  to  draw  on  this  bank  a  draft  against  each  shipment  not  to 
exceed  the  value  of  the  shipment  as  stated  in  the  "invoice"  or  bill 
of  goods  rendered  by  the  selling  to  the  purchasing  merchant. 

*  By  making  proper  arrangements  the  importer  may  with  the 
consent  of  his  bank  have  the  credit  extendedteither  with  respect  to 
the  date  of  its  expiration  or  with  respect  to  the  total  value  of 
drafts  authorized. 


THE  BANK  CREDIT  AND  LETTER  OF  CREDIT      139 

cepting  this  draft  the  drawee  bank  will  detach  the  accom- 
panying copy  of  the  bill  of  lading  and  all  other  collateral 
documents.  It  will  forward  these  to  the  bank  which  wrote 
the  letter  of  credit.  All  other  copies  of  the  bill  of  lading 
will  be  detached  by  the  banker  first  buying  the  draft  and 
forwarded  directly  to  the  "New  York  Customs  Brokers 
Company,"  this  being  the  fictitious  name  we  have  chosen 
for  a  house  engaged  in  the  business  of  receiving  imported 
merchandise  and  clearing  it  through  the  American  customs 
house,  acting  as  an  agent  for  interested  banks  or  merchants. 
Any  bank  dealing  in  foreign  exchange  in  a  large  way  will 
have  established  relations  with  such  agents  at  various  ports 
of  entry  or  points  of  transhipment. 

The  beneficiary  of  a  credit  may  exhaust  it  in  one  draft 
or  he  may  make  a  number  of  partial  shipments  and  draw 
a  number  of  separate  drafts  under  it.  In  the  latter  case 
it  is  his  privilege  not  to  surrender  the  letter  of  credit 
to  the  banker  buying  the  first  draft.  He  needs  to  keep  it 
to  show  his  authority  for  subsequent  drafts.  To  protect 
itself  against  mistaken  or  fraudulent  over-drawing,  the 
bank  which  issues  the  letter  requests  every  banker  that 
buys  a  draft  under  it,  to  make  a  record  of  the  purchase 
in  a  space  provided  in  the  letter  for  that  purpose.  Such 
entries  will  show  the  progressive  exhaustion  of  the  credit. 
The  banker  who  purchases  the  final  draft  is  required  to 
take  up  the  letter,  cancel  it,  and  attach  it  to  the  draft, 
from  which  it  will  be  separated  by  the  drawee  bank  at  the 
time  of  presentment  for  acceptance.  We  need  not  follow 
its  history  as  a  mere  document  of  record  from  this  point 
forward. 

In  our  illustration  we  are  assuming  that  the  Italian 
Olive  Oil  Export  Company  ships  to  the  American  Import 
Company  a  consignment  of  oil  sold  at  a  contract  price  of 
10,000  lire.  Taking  the  bills  of  lading,  insurance  certi- 
ficate, and  other  documents  which  originate  in   this  ship- 


140  FOREIGN  EXCHANGE 

incut,  it  prepares  a  sterling  documentary  bill.  Included 
among  the  documents  will  be  the  invoice  certified  by  the 
local  American  consul,  this  paper  being  called  for  by  the 
letter  of  credit.  It  is  the  Italian  Company's  privilege  to 
draw  upon  the  London  Joint  City  and  Midland  Bank,  Ltd., 
against  this  shipment,  a  draft  for  such  a  number  of  pounds 
Sterling  that  the  instrument  can  sell  at  the  exchange  rate 
of  the  day  for  the  10,000  lire  due  on  account  of  this  ship- 
ment. 

What  the  precise  market  rate  of  exchange  of  the  day  is, 
will  be  declared  by  the  Italian  banker  who  buys  the  draft. 
The  American  bank  and  the  American  importer  rely  upon 
this  banker  to  name  a  fair  rate.  The  lower  or  cheaper 
this  rate,  the  larger  the  number  of  dollars  the  American 
merchant  will  have  to  pay  for  his  goods  in  the  end.  An 
existing  market  rate  is  more  or  less  of  an  established  fact, 
and  through  regular  channels  of  information  the  American 
parties  have  a  check  upon  the  rate  named  by  the  Italian 
bank.  If  there  were  collusion  between  the  Italian  merchant 
and  banker  it  would  become  manifest,  and  in  any  case  most 
foreign  banking  is  conducted  on  too  high  a  plane  to  make 
this  common  or  probable.  As  a  matter  of  theoretical  in- 
terest, however,  it  may  be  pointed  out  in  passing  that  the 
draft-buying  banker  would  profit  by  quoting  a  low  buying 
rate,  insomuch  as  the  lower  the  rate  the  larger  the  number 
of  pounds  sterling  payable  in  London  he  would  obtain 
for  a  given  outlay  of  Italian  lire,  whereas  it  would  make 
no  difference  to  the  merchant  who  draws  the  draft  how 
low  the  rate  might  be,  since  he  is  entitled  to  draw  for 
enough  pounds  to  net  him  a  predetermined  sum  of  lire. 
The  more  pounds  drawn  for,  the  larger  the  number  of 
pounds  the  American  merchant  will  have  to  pay  for  in 
the  end. 

The  Italian  exporting  company  has  a  sixty  days'  sight 
draft  on  a  London  bank  to  offer.     Assume  that  the  rate 


THE  BANK  CREDIT  AND  LETTER  OF  CREDIT      141 

for  this  type  of  exchange  is  25.10  lire  per  pound.  The 
number  of  pounds  of  face  value  of  draft  required  to  yield 
10,000  lire  to  the  drawer  is  calculated  simply  as  follows : 

25.10)10000.00(398.406 
7530 


24700 
22590 

21100 
20080 

10200 
10040 

16000 
15060 

This  shows  that  a  sum  of  10,000  is  398.4  times  as  great  as 
a  sum  of  25.10,  and  that  if  the  drawer  receives  25.10  lire 
for  each  pound  of  exchange  sold  he  must  sell  £398.4  to 
obtain  10,000  lire.  By  the  sale  of  this  bill  the  Italian 
Olive  Oil  Export  Company  receives  payment  for  its  ship- 
ment in  full  in  present  cash.  In  ordinary  course  it  will 
have  nothing  further  to  do  with  the  progress  of  the  draft. 

§  40.  Banking  operations  involved  and  the  acceptance 
account. — The  use  of  letters  of  credit  necessitates  of  course 
a  number  of  banking  operations.  In  discussing  these  we 
can  do  no  better  than  to  continue  with  the  illustration  al- 
ready developed.  The  simpler  case,  where  a  bank  issues 
a  credit  upon  itself  rather  than  upon  some  other  institu- 
tion, will  then  need  no  special  discussion.  Let  us  begin 
with 

I.  The  draft-buying  bank. — The  bank  in  Italy  which 
purchases  the  sixty  days'  sight  sterling  draft  of  the  Italian 
Olive  Oil  Export  Company  may,  in  ordinary  times,  make 
one  of  two  possible  dispositions  of  this  instrument.     (1) 


L42  FOREIGN  EXCHANGE 

It  may  remil  il  forthwith  to  its  London  correspondent  for 
discount  and  cash  credit.  (2)  Exchange  and  money  market 
conditions  being  appropriate,  it  may  choose  a  course  in  some 
respects  quite  opposed  and  withhold  the  draft  from  dis- 
count, with  a  design  to  collect  in  London  its  full  face  value 
at  maturity  instead  of  securing  an  advance  of  the  lesser 
sum  of  its  discounted  present  value.  The  second  course 
of  action  is  called  an  investment  in  exchange.  Invest- 
ments in  exchange  will  be  the  special  subject  of  a  later 
chapter  5  and  we  shall  for  the  present  confine  our  attention 
to  the  case  of  remittance  for  immediate  discount  and  cash 
credit.  As  soon  then  as  the  draft  arrives  in  London,  its 
domicile  city,  it  will  be  presented  by  the  London  corre- 
spondent (or  perhaps  branch)  of  the  Italian  bank  to  the 
drawee  bank  for  acceptance.  Acceptance  having  been  pro- 
cured, the  draft  will  be  discounted  at  the  prevailing  rate 
for  the  acceptance  of  a  bank  in  the  London  money  market 
and  the  proceeds  of  the  discount  will  be  credited  to  the 
deposit  carried  by  the  Italian  bank  with  its  London  corre- 
spondent. The  correspondent  may  effect  the  discount 
either  (1)  by  selling  the  draft  to  any  dealer  or  banker  who 
may  desire  to  purchase  it,  that  is,  by  selling  it  in  the  "open 
money  market"  of  London,  or  (2)  by  buying  the  draft 
itself,  that  is,  by  itself  making  an  advance  of  its  present 
value  to  the  Italian  bank's  account.  It  may  adopt  the 
latter  plan  if  it  happens  itself  to  be  looking  for  an  oppor- 
tunity to  invest  in  paper  of  this  character,  amount,  and 
length  of  life.  It  will  in  this  case  pay  the  same  price  as 
could  be  procured  in  the  open  market.  "Which  alter- 
native is  selected  makes  no  difference  to  the  remitting 
bank.6 

From  this  point  forward  the  Italian  bank  has  in  regular 
course  no  further  concern  in  the  life  of  the  draft  itself. 

s  Hee  Chapter  XL 

6  Compare,  however,  §  62  beneath,  on  the  arrival  discount  rate. 


THE   BANK  CREDIT  AND  LETTER  OF  CREDIT      143 

We  have  not,  however,  concluded  with  the  operations  im- 
posed on  this  bank  by  reason  of  its  purchase  of  the  instru- 
ment. Every  purchase  of  sterling  exchange  made  at  the 
bank's  home  office  in  Italy  means  an  expenditure  of  lire 
there  and  a  gain  of  pounds  in  the  bank's  London  deposit.7 
Such  a  purchase  has,  therefore,  taken  by  itself  the  effect 
of  transferring  some  of  the  bank's  funds  from  Italy  to 
London.  In  order  to  prevent  its  working  capital  from 
being  gradually  removed  to  London,  the  bank  in  Italy  must 
in  the  long  run  manage  to  sell  as  much  sterling  exchange 
as  it  buys^/  For  sales  of  exchange  have  the  effect  of  bring- 
ing in  money  in  Italy  and  of  reducing  the  London  deposit,8 
that  is,  the  effect  of  making  a  re-transfer  of  funds  from 
London  to  Italy.  And  so  we  must  conceive  of  each  pur- 
chase of  a  sterling  draft,  whether  drawn  under  a  letter 
of  credit  or  not,  as  involving  ultimately  the  countervailing 
operation  of  the  sale  of  an  equivalent  amount  of  sterling 
exchange  by  the  purchasing  bank  in  Italy.  Our  meaning 
is  of  course  that  the  total  .purchases  of  sterling  for  a  day 
must  be  substantially  evened  up  by  sales  on  the  same  day 
or  very  shortly  thereafter.  Each  purchase  thus  theoret— — 
ically  involves  a  countervailing  sale.  Profits  come  from 
a  difference  between  the  buying  and  selling  rates.  (The 
Italian  bank  is  naturally  under  an  equal  necessity  of  buy- 
ing as  much  exchange  as  it  sells,  if  it  designs  to  prevent 
the  funds  in  the  London  balance  from  flowing  back  to  the 
home  office.)  The  issue  of  the  letter  of  credit  of  our  illus- 
tration means,  then,  the  purchase  of  sterling  exchange  by 

7  In  case  the  Italian  bank  invests  in  a  long  sterling  bill,  the  gain 
in  pounds  in  London  is  not  eliminated  but  is  merely  postponed. 

8  The  sale  of  sight  bills  on  the  London  correspondent  is  simply  a 
case  of  cheeking  on  the  balance  with  that  correspondent  and  reduces 
this  balance  or  deposit  in  precisely  the  same  way  as  the  drawing 
of  a  check  by  any  ordinary  depositor  with  a  bank.  Regarding  the 
sale  of  long  bills  on  the  correspondent,  see  Chapter  XII. 


144  FOREIGN  EXCHANGE 

BOme  Italian  bank  and  further  in  regular  course  a  counter- 
vailing sale  of  Bterling  exchange  by  the  same  bank  upon 
the   Italian   market  for  sterling.9 

II.  Tlu  accepting  bank. — In  the  .illustration  in  hand,  the 
accepting  bank  is  assumed  to  be  the  London  Joint  City  and 
Midland.  (1)  The  first  event  at  this  bank  connected  with 
the  letter  of  credit  will  be  its  receipt  from  its  American  cor- 
respondent, the  Hundredth  National  of  Chicago,  of  a  copy 
of  the  letter,  or  perhaps  some  other  form  of  advice,  which 
will  convey  full  information  as  to  what  may  be  expected  in 
the  waj-  of  drafts  drawn  by  the  Italian  Olive  Oil  Export 
Company.  (2)  The  next  event  will  be  the  presentment  of  a 
draft  of  this  company  to  the  London  Joint  City  and  Mid- 
land Bank  for  acceptance.  The  presentment  will  be  made 
by  the  correspondent  of  the  Italian  draft-buying  bank. 
The  American  bank  has  represented  that  acceptance  will 
be  granted.10  The  London  bank  has  made  an  agreement 
with  the  American  bank  that  it  will  accept  drafts  authorized 
by  it,  within  the  terms  of  the  "acceptance  account."  Thus 
acceptance  will  take  place  and  the  date  of  maturity  of  the 
draft  will  fall  sixty-three  days  after  the  date  of  the  accept- 
ance, unless  the  three  days  of  grace  allowed  by  English 
law  are  waived.  The  days  of  grace  are  not  waived  in 
usual  practice. 

The  Acceptance  Account 

(3)  In  the  third  place  will  come  the  charging  of  the 
"  acceptance  account"  of  the  Hundredth  National  of  Chicago. 
It  has  already  been  stated  that  the  grant  of  an  acceptance 
account  is  the  extension  to  the  grantee  of  an  authority  to 

»  This  statement  is  based  on  the  assumption  that  the  Italian  bank 
will  desire  to  have  its  working  balance  in  London  remain  at  a 
practically  steady  figure  from  day  to  day.  There  are  times  of 
course  when  it  will  desire  to  expand  or  contract  its  London  funds. 

io  Regarding  the  "confirmed  Utter  of  credit,"'  sec  §47  below. 


THE  BANK  CREDIT  AND  LETTER   OF  CREDIT      145 

draw  long  bills  upon  the  grantor  (that  is,  to  draw  bills  for 
the  latter 's  acceptance)  or  to  authorize  others  to  draw  such 
bills.  To  charge  a  draft  to  this  account  means  to  make  a 
record  of  its  acceptance  on  the  date  when  this  event  takes 
place.  When  the  draft  is  paid  at  maturity  it  will  be 
charged  off  the  acceptance  account,  and  the  amount  paid 
will  be  immediately  deducted  from  the  cash  credit,  or  bal- 
ance, of  the  grantee  bank,  which  is  obligated  to  provide 
the  funds  for  the  discharge  of  the  instrument.  At  any 
moment  the  record  will  show  the  total  amount  of  accept- 
ances outstanding,  or  the  total  sum  of  unmatured  drafts 
upon  which  at  one  date  or  another  the  London  bank  has 
become  liable  as  obligor,  at  the  request  of,  or  for  the  account 
of,  the  American  bank.  Almost  always  an  acceptance  ac- 
count is  granted  upon  two  conditions.  These  are  (1)  the 
amount  of  acceptances  outstanding  at  any  one  time  must 
not  exceed  a  specified  limit,  and  (2)  the  amount  outstanding 
at  all  times  must  be  protected  by  collateral  security.  The 
effect  of  the  first  condition  is  either  to  prevent  the  grantee 
bank  from  drawing  or  authorizing  long  drafts  when  this 
action  would  cause  the  total  of  acceptances  to  ascend  above 
the  prescribed  limits,  or  to  force  it  to  put  up  cash  to  cover 
any  such  surplus  drafts.  The  second  condition  signifies 
that  the  grantee  bank  must  have  on  deposit  at  all  times 
acceptable  securities  equal  in  value  to  the  outstanding 
acceptances  (or  perhaps  exceeding  them  in  value  by  a  pre- 
scribed percentage  as  margin).  The  securities  are  not 
necessarily  physically  on  deposit  with  the  grantor  bank  it- 
self, but  may  be  placed  in  the  custody  of  some  agent  in 
America,  such  as  a  trust  company,  chosen  to  receive  them. 
The  bank  depositing  securities  as  collateral  retains  owner- 
ship in  them  and  receives  the  interest  or  dividends  which 
they  pay. 

The  present  writer  has  reason  to  believe  that  acceptance 
accounts  are  occasionally  granted  Eree  from  one  or  both  <>f 


IKi  FOREIGN  EXCHANGE 

the  conditions  jusl  described.  If  no  formal  limit  is  placed 
upon  the  total  of  acceptances,  the  meaning  is  not  precisely 
thai  unlimited  drawings  would  be  tolerated,  but  rather 
thai  the  limit  is  lefl  in  the  discretion  of  the  grantee  bank. 
Bounds  exist  but  arc  not  expressly  defined.  The  absence 
of  the  requirement  of  collateral  would  indicate  great  con- 
fidence  in  the  financial  strength  of  the  grantee  bank.  There 
are.  however,  probably  many  banks  which  never  grant  an 
acceptance  account  without  collateral.  The  reason  for  the 
usual  demand  for  this  security  is  readily  perceived.  The 
grantor  bank  becomes  unconditionally  bound  to  pay  at  ma- 
turity all  the  drafts  it  has  accepted.  It  pays  them  with 
the  expectation  that  it  will  be  reimbursed  on  the  day  of 
payment  by  the  grantee  bank  which  has  drawn  or  author- 
ized them.  But  it  is  bound  to  pay  without  regard  to 
whether  this  reimbursement  is  actually  forthcoming.  If 
the  grantee  bank  should  fail  while  acceptances  were  out- 
standing, the  reimbursement  would  probably  not  material- 
ize, at  least  not  when  due.  It  would  probably  be  much 
delayed  and  then  would  be  for  only  a  certain  fraction  of 
the  amount  owed.  The  unimpaired  cash  balance  of  the 
failed  bank  might  be  insufficient  to  provide  the  reimburse- 
ment. Under  these  circumstances  the  collateral  could  be 
seized  and  sold. 

The  following  statements  are  of  interest  as  bearing  upon 
the  practice  respecting  collateral  of  two  large  London 
banks.  In  1909  or  1910,  Sir  Felix  Schuster,  Governor  of 
the  Union  of  London  and  Smith's  Bank,  said  in  an  inter- 
view given  for  the  United  States  Monetary  Commission : 
"We  do  not  give  what  are  called  open  credits,  and  every 
acceptance  is  covered  by  a  deposit  of  security."  1X  A  simi- 
lar assertion  was  also  made  with  respect  to  the  London  Joint 

11  See  "Interviews  on  Banking  and  Currency  Systems,"  U.  S. 
Monetary  Commission,  p.  37.  (This  is  Senate  Document  405,  61st 
Congress,  2d  session.) 


THE  BANK  CREDIT  AND  LETTER   OF  CREDIT      147 

Stock  Bank  by  its  General  Manager,  Mr.  Charles  Gow.12 
Acceptance  of  a  long  bill  is  in  one  respect  unlike  the 
certification  (i.e.,  acceptance)  of  a  sight  bill  or  check.  In 
the  case  of  certification,  the  drawee  bank  assumes  a  demand, 
instead  of  a  deferred  liability  for  the  account  of  the 
drawer,  and  it  therefore  immediately  removes  or  sequesters 
from  his  deposit  a  sufficient  sum  to  discharge  the  instru- 
ment. 

(4)  The  fourth  event  at  the  accepting  bank  will  be  the 
payment  of  the  draft  at  maturity.  (5)  The  fifth  and  last 
will  be  the  immediately  ensuing  deduction  of  the  amount 
thus  paid,  from  the  American  bank's  cash  balance  or  de- 
posit. It  is  the  province  of  the  latter  institution  to  fortify 
its  balance  for  reductions  of  this  character. 

III.  The  credit-issuing  bank. — The  institution  which 
writes  the  letter  of  credit  (in  this  instance,  the  Hundredth 
National  of  Chicago),  (1)  issues  this  document  at  the  re- 
quest of  the  importer  and  in  return  for  a  contract  of  reim- 
bursement signed  by  him  (compare  the  next  section).  (2) 
It  receives  advices.  That  is,  as  the  letter  is  put  to  use 
and  the  drafts  drawn  under  it  become  the  acceptances  of 
the  London  correspondent,  it  receives  information  as  to 
the  amounts  and  dates  of  these  acceptances.  From  this  it 
reckons  the  dates  of  payment  and  the  deductions  that  will 
be  made  from  its  London  balance,  and  thus  learns  its  exact 
requirements  for  "cover,"  or  for  sterling  exchange  to  be 
purchased  in  the  United  States  and  remitted  to  London 
to  supply  or  compensate  for  these  deductions.  (3)  Next  is 
the  collection  from  the  importer  of  a  sum  of  dollars  suffi- 
cient to  purchase  this  cover  and  pay  the  commissions 
charged  for  furnishing  the  credit.  (4)  The  final  step  is  the 
actual  purchase  of  the  sterling  and  the  remittance  of  it  to 
the  London   correspondent   for   account.     This  should   be 

12  The  same,  p.  G5. 


L48  KOWKMJN   KXOIIANGE 

conceived  of  as  a  normal  final  step,  but  it  might  of  course 
be  omitted  if  tin'  bank  at  the  time  was  desirous  of  reduc- 
ing its  London  balance,  as  a  measure  of  transferring  foreign 

funds  home. 

§  41.  The  contract  for  a  letter  of  credit. — A  letter  of 
credit  is  itself  a  contract.  The  person  who  upon  the  faith 
of  it  purchases  drafts  drawn  under  its  authority  and  in 
accordance  with  its  terms,  may  maintain  an  action  in  his 
own  name  for  breach  of  contract  against  the  writer  of  the 
letter,  in  the  event  that  the  designated  drawee  dishonors 
the  drafts  whether  by  non-acceptance  or  by  non-payment. 
This  is  true  provided  the  letter  was  issued  for  a  considera- 
tion and  provided  the  drafts  wrere  purchased  without 
knowledge  of  any  irregularity  or  fraud  in  their  origin,  and 
for  value.  There  are  certain  other  minor  conditions  into 
which  we  need  not  go. 

The  consideration  for  which  the  letter  of  credit,  itself 
a  contract,  usually  issues  is  another  contract,  namely  the 
contract  for  a  letter  of  credit  entered  into  by  the  importer 
with  the  banker  who  issues  the  letter.  The  provisions  of 
this  agreement  vary  in  different  countries  and  to  a  certain 
extent  between  banks  in  a  given  country.  We  shall  be 
content  to  analyze  and  reproduce  one  which  may  be  re- 
garded as  typical  in  the  United  States.  Its  two  chief  pro- 
visions (1)  obligate  the  merchant  to  reimburse  the  bank 
for  the  outlays  wThich  it  will  make  by  reason  of  having 
issued  the  letter,  and  (2)  give  the  bank  a  claim  upon  the 
imported  merchandise  as  collateral  security.  Fuller  analy- 
sis will  disclose  the  following  clauses. 

1.  The  person  procuring  the  credit  expressly  acknowl- 
edges his  agreement  to  the  terms  of  the  letter  of  credit 
itself. 

2.  He  undertakes  to  reimburse  the  bank  and  usually 
under  the  following  plan.  A  specified  number  of  days 
before  the  maturity  of  each  draft  drawn  under  the  letter, 


THE  BANK  CREDIT  AND  LETTER  OF  CREDIT      149 

he  promises  to  furnish  the  bank  a  sum  of  money  sufficient 
to  purchase  at  the  then  prevailing  rate  of  exchange  a  first 
class  banker's  sight  bill  on  London  for  the  number  of 
pounds  required  to  cover  or  discharge  the  maturing  draft. 
Sometimes  his  promise  reads  either  to  furnish  this  sufficient 
sum  of  money  or  else  himself  to  provide  the  first  class 
banker's  draft.  The  number  of  days  by  which  this  inpay- 
ment by  the  merchant  must  antedate  the  maturity  of  the 
draft,  was,  for  instance,  in  Chicago  usually  fifteen.  This 
statement  holds  good  for  sterling  credits  as  issued  under 
conditions  preceding  the  war. 

3.  The  applicant  for  the  credit  also  agrees  to  pay  the  bank 
a  certain  commission  for  its  services. 

4.  He  agrees  to  clauses  establishing  the  bank's  interest 
in  the  merchandise  as  collateral   (see  discussion  in  §42). 

5.  The  power  of  the  bank  to  sell  the  merchandise  in  case 
of  need  is  expressly  agreed  to. 

6.  The  merchant  consents  to  the  application  of  any  sur- 
plus funds  which  might  arise  from  such  a  sale,  to  the  dis- 
charge of  any  other  indebtedness  which  he  might  owe  the 
bank. 

7.  The  applicant  for  the  credit  agrees  that  the  bank  is 
not  to  be  responsible  for  the  character  of  the  merchandise 
or  for  the  genuineness  or  correctness  of  the  bill  of  lading. 
The  point  here  is  that  if  the  foreign  merchant  ships  goods 
different  from  those  promised,  or  below  the  grade  con- 
tracted for,  so  that  the  importer  would  come  to  have  a 
right  to  reject  the  goods,  this  shall  not  affect  his  obligation 
to  settle  with  the  bank  for  the  drafts  which  have  been 
drawn  upon  and  accepted  by  its  London  correspondent.13 
Neither  of  the  bankers  involved  is  making  a  speculatio7i 
on  the  sufficiency  of  the  goods.     This  is  not  their  business. 

13  Or,  in  the  other  case,  it  shall  not  affect  the  obligation  to  settle 
for  drafts  which  have  been  drawn  upon  and  accepted  by  the  bank 
itself. 


FOREIGN   EXCHANGE 

The  liability  of  tin*  London  banker  to  pay  his  acceptance 
at  maturity  is  not  conditioned  on  the  sufficiency  of  the 
goods,  li'  it  were,  by  the  way,  the  acceptance  would  by 
do  means  possess  the  salability  on  the  London  money  mar- 
ket it  has.  Likewise  the  liability  of  the  American  bank 
to  reimburse  the  London  bank  for  its  payment  of  this 
acceptance  is  not  conditioned  upon  the  sufficiency  of  the 
goods.  If  it  were,  the  London  banker  would  never  have 
been  willing  to  grant  the  acceptance.  Finally  the  liability 
of  the  American  importer  to  reimburse  the  American 
banker  is  not,  of  course,  to  be  conditioned  upon  his  satis- 
faction with  the  merchandise.  He  would  have  to  pay  even 
if  water  were  fraudulently  shipped  for  say  olive  oil.  If 
the  goods  fail  to  meet  the  requirements  of  the  contract 
of  sale,  the  importer  will  have  some  sort  of  action  at 
law  (perhaps  practically  worthless)  for  reimbursement 
from  the  foreign  exporter,  and  this  is  all  he  will  have.  He 
cannot  refuse  payment  for  the  goods  to  the  credit-writing 
banker. 

8.  The  applicant  for  the  credit  often  agrees  to  furnish 
the  bank  security  in  addition  to  its  interest  in  the  im- 
ported merchandise,  if  this  is  demanded. 

9.  It  is  in  some  cases  agreed  that  the  bank  may  revoke 
the  authoritj"  conferred  by  the  letter  of  credit,  save  that 
the  beneficiary  shall  always  be  entitled  to  use  so  much  of 
the  credit  as  is  necessary  to  reimburse  him  for  goods  shipped 
and  goods  started  in  process  of  collection  or  manufacture 
before  he  receives  notice  of  the  revocation.  Revocation  is 
dangerous  and  unsatisfactory  because  it  is  in  any  event  good 
only  against  persons  who  have  received  notice  of  the  revoca- 
tion. Any  other  person  buying  a  draft  on  the  strength  of 
the  letter  is  protected  by  it  despite  a  revocation.  Letters 
of  credit  are  usually  spoken  of  as  being  irrevocable.14 

i*  The  specimen  form  of  agreement  for  a  commercial  letter  of 
credit  given  in  Margraff's  "International  Exchange,"  p.  92,  contains 


THE   BANK  CREDIT  AND  LETTER  OF  CREDIT      151 

The  following  is  a  form  of  agreement  against  which  the 
International  Banking  Corporation  issues  commercial  let- 
ters of  credit  for  its  clients. 

New  York, 191.. 

To 

The  International  Banking  Corporation, 
New  York  City. 

In  consideration  of  your  having  opened  for  my  (our)  account  a 

credit  No ,  dated 

for    

with    

in  favor  of 

to  be  used  within months  from  this  date  by 

,  against  delivery  of  documents,  viz. : 


I  (we)  hereby  agree  to  its  terms  and  bind  myself  (ourselves)  to 

furnish  you  not  later  than days  before  the  maturity 

of  the  acceptances  under  it,  with  approved  bankers'  demand  bills 
of  exchange,  for  the  same  amount  payable  in  London  and  bearing 
my  (our)  endorsement  or  to  pay  equivalent  thereof  in  cash  at  the 
rate  of  exchange  at  which  you  may  be  then  drawing  upon  demand 
on  London. 

I   (we)   further  agree  to  pay  your  commission  at  the  rate  of 

%  for  such  part  of  this  credit  as  shall  be  used  together 

with  all  expenses  incurred. 

It  is  also  understood  that  you  are  not  to  be  held  responsible  in 
any  way  for  the  description  or  quality  of  the  merchandise  shipped, 
or  for  the  correctness  of  the  documents  presented  by  the  parties 
in  whose  favor  or  to  whom  the  credit  is  issued. 

And  I  (we)  hereby  recognize  and  admit  the  ownership  of  The 
International  Banking  Corporation  and  its  right  and  the  right 
of  its  Agents  to  the  possession  and  disposal  of  all  goods  and  the 
proceeds  thereof  for  which  The  International  Banking  Cor- 
poration may  come  under  any   engagements  in  virtue  of  tins 

a  clause  authorizing  revocation.  The  same  clause  also  appears  in  a 
contract  reproduced  in  Brooks'  "Foreign  Exchange  Text  Book," 
p.   176. 


L62  FOREIGN  EXCHANGE 

ere. lit  as  also  to  the  possession  of  all  Bills  of  Lading  for  and 
policies  of  insurance  on  such  goods  until  such  time  as  any  indebt- 
edness or  liability  existing  as  against  me  (us)  in  favor  of  The 
International  Banking  Corporation  under  the  said  credit  or 
otherwise  shall  have  been  fully  paid  up  and  discharged  and  in  the 
event  o['  the  said  goods  being  entrusted  to  me  (us)  for  the  purpose 
of  sale  or  otherwise  1  (we)  hereby  consent  that  the  right  of  The 
International  Banking  Corporation  or  its  Agents  to  repossess 
themselves  of  the  same  or  of  any  proceeds  thereof,  may  be  exer- 
cised at  their  discretion. 

Any  proceeds  of  said  goods  coming  into  the  hands  of  The 
International  Banking  Corporation  are  to  be  applied  against 
any  acceptances  under  this  credit,  or  against  any  other  indebted- 
ness of  me  (us)  to  it,  including  all  expenses  incurred  and  commis- 
sion of  sale  and  guarantee. 

The  Marine  Insurance  to  be  done  by 

This  obligation  is  to  continue  in  force  and  be  applicable  to  all 
transactions,  notwithstanding  any  change  in  the  individuals  com- 
posing any  firm,  parties  to  or  concerned  in  this  contract,  whether 
such  change  shall  arise  from  the  acquisition  of  one  or  more  new 
partners  or  from  the  death  or  secession  of  any  partner  or  partners. 


Dated, ,  191. .. 

§  42.  The  banker's  legal  interest  in  the  merchandise. — 
The  banker  who  holds  a  bill  of  lading  as  collateral  has  a 
legal  interest  in  the  merchandise  represented  by  this  docu- 
ment. The  general  design  of  this  interest  is  clear  enough, 
but  its  technical  nature  and  extent  are  not  so  clear  in  all 
cases.  It  often  amounts  to  "ownership"  or  the  holding 
of  "title."  But  at  times  it  is  at  law  referred  to  merely 
as  a  jus  disponendi  or  right  of  disposal  or  control.  Some- 
times it  appears  to  be  only  a  "lien."  In  the  specimen 
"trust  receipt"  presently  to  be  given,  acknowledgment  is 
made  of  the  banker's  ownership  of  the  merchandise.  Own- 
ership, when  gained,  is  often  referred  to  as  a  "special  prop- 


THE  BANK  CREDIT  AND  LETTER  OF  CREDIT      153 

erty"  or  "special  title,"  because  the  banker  may  be  di- 
vested of  it  if  the  merchant  who  is  the  real  purchaser  of 
the  goods  performs  all  his  obligations.  As  a  matter  of 
law,  the  technical  extent  of  the  banker's  interest  depends 
on  the  intention  of  the  parties  concerned  as  shown  in  the 
words  of  their  agreements  and  in  the  circumstances. 

For  our  purposes  we  shall  say  that  the  banker  obtains 
an  acknowledged  legal  interest  in  the  merchandise,  and 
that  the  main  rights  involved  in  the  interest  are  fairly 
clear  in  most  cases.  (1)  The  banker  has  a  power  of  sale 
over  the  goods,  to  be  exercised  upon  the  condition  that  the 
real  purchaser  fails  to  perform  his  obligations.  (2)  The 
banker  is  accountable  to  the  merchant  (exporter  or  im- 
porter as  the  case  may  be  15)  for  any  surplus  in  the  pro- 
ceeds of  the  sale  over  what  is  necessary  to  discharge  in 
full  the  debt  due  him,  including  costs  and  charges  and  in- 
terest for  delay.  In  practice  such  a  surplus  is  rare,  be- 
cause the  goods  go  at  forced  sale.  (3)  The  banker's  claim 
to  the  merchandise  is  superior  to  that  of  an  attaching 
creditor  of  either  merchant.10 

15  The  party  to  whom  the  banker  is  accountable  for  any  surplus 
is  the  one  who  is  liable  to  make  up  to  the  banker  any  deficiency  in 
the  proceeds  of  the  sale.  This  is  the  one  at  whose  request,  and 
against  whose  agreement  of  reimbursement,  expressed  or  implied, 
the  banker  has  either  (1)  bought  the  draft  arising  in  the  shipment 
or  (2)  become  responsible  for  its  payment.  Thus  the  person  is  the 
exporter  in  the  case  where  the  banker  has  bought  the  latter's  draft 
drawn  directly  on  the  importer.  If  the  importer  dishonors  the  bill, 
the  exporter  is  liable  for  its  payment  (under  the  implied  contract 
of  a  drawer  or  under  the  express  contract  of  the  letter  of  hypothe- 
cation), but  if  his  goods  are  sold  he  will  be  entitled  to  receive  the 
surplus  proceeds  of  the  sale,  if  any.  The  person  to  receive  the  same 
surplus,  in  the  case  of  the  ordinary  commercial  letter  of  credit,  is 
the  importer,  who  will  (because  of  his  express  agreement  to  do  so  in 
the  ordinary  case)  have  to  make  up  a  deficiency  in  the  proceeds 
when  there  is  a  deficiency.  | 

10  In  the  footnote  on  page  154  will  be  found  a  few  legal  points  re- 
specting the  banker's  interest  in  the  merchandise. 


i;,l  FOREIGN  EXCHANGE 

§  43.  Release  of  the  goods  to  the  importer.  The  "trust 
receipt."  As  our  studies  to  this  point  would  lead  us  to 
expect,  it  is  usual  though  not  universal  for  the  importer 
to  find   the  bill  of  lading  pertaining  to  his  goods  in  the 

Where  a  l>ill  of  lading  is  made  out  to  the  order  of  the  seller  and 
indorsed  by  him  in  blank,  or  else  made  out  to  the  order  of  a  third 
party,  the  intention  of  the  parties  is  the  ultimate  criterion  by  which 
we  arc  tn  judge  whether  title  passes  to  the  vendee  at  the  time  of 
delivery  t<>  the  carrier.  The  presumption  from  this  form  of  en- 
dorsemenl  is  that  title  was  withheld  from  the  vendee,  but  it  is 
generally  recognized  that  this  presumption  is  not  conclusive.  2 
I. tinners'  Reports  Annotated  (XS)  10G8-81n,  and  cases  there  dis- 
cussed. 

"Where  hanker.-  issued  mercantile  letters  of  credit  to  merchants 
under  an  agreement  that  goods  purchased  by  means  of  the  credit, 
as  well  as  bills  of  lading  of  such  goods,  should  be  held  by  the  bankers 
for  security,  pursuant  to  which  agreement  bills  of  lading  were  "made 
out  to  the  order  of  the  bankers  and  sent  directly  to  them  by  the 
sellers  of  the  goods,  the  bankers  obtain  title  to  the  goods."  Moors  v. 
Bird,  77  X.  E.  643,  190  Mass.  400  (1906),  cited  in  Jf  Decennial 
Digest  '06,  p.   123. 

Many  cases  show  that  the  real  consignee  does  not  get  title  until 
he  pays  for  the  draft  to  which  the  bill  of  lading  is  attached  as 
collateral,  and  it  has  been  held  that  this  is  true  even  when  the  bill 
of  lading  is  made  out  direct  to  the  consignee.  17  Decennial  Digest 
'06,  p.  1962. 

"A  pledgee  to  whom  a  bill  of  lading  is  given  as  security  gets  the 
legal  title  to  the  goods  and  the  right  of  possession  only  if  such  is 
the  intention  of  the  parties,  and  that  intention  is  open  to  explana- 
tion." The  Carlos  F.  Roses,  177  U.  S.  655,  as  cited  in  the  "American 
and  English  Encyclopedia  of  "Law,"  Second  Edition,  Supplement, 
Vol.  I,  p.  666n. 

A  Uniform  Bills  of  Lading  Act  designed  for  the  purpose  of  sys- 
tematizing and  simplifying  the  law  governing  the  rights  of  the 
several  parties  concerned  in  this  important  instrument  of  commerce 
has  been  passed  by  a  number  of  states  of  the  American  Union.  In 
June,  1911,  the  list  of  these  states  included  Massachusetts,  Xew 
York,  Pennsylvania,  Maryland,  Ohio,  Michigan,  Illinois  and  Iowa 
(Commercial  and  Financial  Chronicle  for  June  24,  1911,  p.  1676). 
The  Massachusetts  statute,  passed  March  4,  1910,  constitutes  Chap- 
ter 214  of  the  Acts  of  1910  of  that  state. 


THE  BANK  CREDIT  AND  LETTER   OF  CREDIT      155 

possession  of  some  banker  at  the  place  of  import.  Atten- 
tion has  already  been  directed  to  three  of  the  principal 
plans  of  settlement  which  bring  about  this  result.  These 
are  settlement  by  documentary  draft  of  the  exporter  (1) 
upon  the  importer  personally,  or  (2)  upon  a  bank  in  the 
importer's  city  procured  by  the  latter  to  serve  as  drawee, 
or  (3)  upon  a  bank  in  some  other  city  or  country  appointed 
by  a  bank  in  the  importer's  city.  Under  the  first  plan, 
the  bill  of  lading  will  be  held  by  a  bank  in  the  importer's 
city,  which  is  the  correspondent  and  collecting  agent  of 
some  foreign  institution  that  has  bought  the  exporter's 
draft,  or  which  has  itself  purchased  the  draft  through  a 
branch  or  correspondent.  Under  the  second  and  third 
plans,  the  importer's  own  bank  comes  to  hold  the  bill  of 
lading,  either  because  it  has  authorized  and  accepted  a 
documentary  draft  upon  itself  (as  under  the  second  plan), 
or  because  it  has  become  responsible  for  a  draft  which 
it  has  authorized  on  a  bank  in  another  city  or  country 
(as  under  the  third  plan).  In  the  instance  of  the  third 
plan,  the  documents  are  forwarded  immediately  to  the 
credit-writing  bank,  or  to  its  customs  house  brokers,  b}r  the 
banker  who  purchases  the  exporter's  draft  at  its  point  of 
origin.  To  fortify  ourselves  against  possible  confusion,  let 
us  consider  a  new  illustration  of  this  case. 

Suppose  the  California  Importing  Company,  in  arrang- 
ing to  buy  goods  from  a  merchant  in  Hongkong,  procures 
from  a  San  Francisco  bank  a  sterling  credit  in  favor  of 
this  merchant.  The  latter  draws  on  the  designated  London 
bank  and  sells  the  draft  to  some  banker  in  Hongkong,  who 
will  in  usual  course  send  it  to  London  for  discount  and 
credit.  One  of  the  several  copies  of  the  bill  of  lading  will 
accompany  the  first  of  exchange,  or  first  copy  of  the  draft, 
to  London.  It  will  be  sent,  however,  not  as  collateral  but 
simply  as  a  matter  of  record  to  show  that  the  drafl  is  in 
order  and  conforms   to   the   instructions  of  the   letter  of 


L66  FOREIGN  EXCHANGE 

credil  authorizing  it.  The  other  copies  of  the  hill  of  lading 
will  be  sent  directly  by  the  draft-purchasing  banker  to  the 
S;ui  Francisco  bank  thai  issued  the  credit.  The  Hong- 
kong banker  is  content  with  the  guarantee  found  in  the 
San  Francisco  bank's  letter  of  credit,  that  the  London 
bank  will  honor  t he  draft.  He  is  willing  to  release  the 
documents  against  this,  just  as  he  would  be  against  a  bank's 
acceptance  of  the  draft.  Thus  he  does  his  share  in  for- 
warding the  plan  of  settlement,  one  object  of  which  is  to 
get  the  bill  of  lading  to  San  Francisco,  the  point  of  import, 
while  keeping  it  in  the  control  of  the  risk-taking  bank, 
the  credit-writing  bank  of  that  city. 

Since  the  draft  drawn  under  any  of  the  plans  of  settle- 
ment at  present  in  hand,  is  quite  likely  to  be  at  sixty  or 
ninety  days  sight,  if  not  for  an  even  longer  usance,17  the 
importer's  goods  will  commonly  arrive  some  time  before 
the  date  when  he  will  be  contractually  bound  to  make 
payment.  In  the  case  of  the  bill  drawn  on  the  importer 
himself,  this  date  will  be  the  sixty  or  ninety  days  after 
his  acceptance.  In  the  case  of  the  Hongkong  draft  on  the 
London  bank,  it  will  be  a  stipulated  number  of  days  (per- 
haps 20)  before  the  maturity  of  the  London  acceptance. 
In  any  event  the  goods  are  likely  to  arrive  before  the 
date  when  the  importer  is  finally  bound  to  make  payment. 
Placing  to  one  side  the  case  of  a  draft  on  the  importer  with 
documents  for  acceptance,  we  come  now  to  consider  the 
question  of  the  ways  and  means  open  to  the  importer  to 
obtain  his  goods  at  an  earlier  date  than  the  day  of  ma- 
turity of  his  contractual  debt. 

At  least  four  principal  arrangements  to  effect  this  result- 
may  be  made  between  the  importer  and  the  banker  hold- 

"  "Usance"  is  a  term  employed  to  mean  either  (1)  simply  the 
length  of  life  of  any  draft  as  it  actually  is,  or  (2)  the  customary 
length  of  life  of  drafts  drawn  in  particular  lines  of  trade,  as  the 
trade  in  silk  of  the  Chinese  coast  with  England  or  what  not. 


THE  BANK  CREDIT  AND  LETTER   OF  CREDIT      157 

ing  the  collateral.  I.  The  banker  may  merely  hand  over 
the  documents,  the  bill  of  lading  and  the  rest,  without  any 
special  security,  taking  from  the  importer  a  mere  receipt 
for  them.  This  is  the  practice  at  least  with  some  banks 
where  the  importer  is  a  person  in  high  repute,  especially 
if  a  regular  customer  of  the  bank  itself.  In  the  instance 
where  the  local  banker  holds  the  documents  as  the  agent  of 
some  foreign  bank — as  is  the  case  when  he  has  received 
a  documentary  payment  draft  for  collection  from  some 
foreign  correspondent — he  may  deliver  the  documents  to 
the  importer  against  the  latter 's  mere  receipt,  even  with- 
out authorization  from  the  correspondent  bank.  But  if  he 
does  this,  or  makes  any  arrangement  with  the  importer 
not  contemplated  in  the  documentary  instructions,  he  will 
act  on  his  own  responsibility  and  will  have  to  make  good 
any  losses  which  the  correspondent  might  chance  to  suffer 
on  account  of  this  arrangement.  With  certain  firms,  never- 
theless, some  bankers,  at  least,  are  willing  to  take  risks  of 
this  kind. 

II.  A  second  arrangement  is  the  surrender  of  the  docu- 
ments to  the  importer  in  return  for  the  latter 's  "trust 
receipt."  This  instrument  is  often  called  a  "trust"  re- 
ceipt whether  in  a  technical  legal  sense  what  it  creates  is  a 
real  "trust,"  or  an  agency  or  a  bailment.  Under  the  sec- 
ond arrangement,  we  may  say  the  importer  obtains  posses- 
sion of  the  goods  as  trustee,  agent,  or  bailee,  for  the  bank. 
Avoiding  precise  questions  of  law,  the  general  purport  or 
effect  is  (1)  to  permit  the  importer  to  obtain  the  goods  and 
deposit  them  in  a  warehouse  or  place  of  storage  agreeable 
to  the  banker,  and  (2)  to  keep  the  banker's  claim  upon 
the  goods  as  creditor  superior  to  that  of  any  other  creditor 
the  importer  may  have.  To  make  certain  of  the  latter 
object,  not  only  must  the  receipt  be  drawn  in  a  manner 
clearly  recognizing  the  banker's  prior  rights,  1ml  the  goods 
must  be  handled  in  such  a  way  that  they  can  at  all  times 


FOREIGN   EXCHANGE 

be  identified.  If  they  wore  mingled  with  other  merchan- 
dise so  that  their  identity  should  be  lost,  the  special  rights 
of  the  banker  in  them  would  disappear,  and  his  position 
would  become  that  of  a  general  creditor  among  other  gen- 
eral creditors. 

The  importer  agrees  to  bring  the  proceeds  of  the  sale  of 
the  goods,  or  of  the  sales  of  them  by  lot  and  parcel,  to  the 
bank  immediately  upon  their  receipt.  The  writer  is  in- 
formed that  the  bank  does  not  customarily  force  the  im- 
porter to  make  known  the  fact  of  his  indebtedness  to  it, 
to  merchants  or  others  to  whom  he  may  make  sales.  Mr. 
Franklin  Escher  states  that  much  difference  of  opinion 
exists  among  foreign  exchange  men  regarding  the  value  of  a 
trust  receipt  from  the  standpoint  of  security.18  The  trust 
receipt  is  employed  in  banking  for  domestic  commerce,  but 
by  no  means  to  the  same  extent  as  in  banking  for  foreign 
commerce.  The  following  is  a  specimen  of  this  instru- 
ment.19 

TRUST  RECEIPT 

Received,  upon  the  trust  hereinafter  mentioned,  from  the  In- 
ternational Banking  Corporation  the  following  goods  and  mer- 
chandise, the  property  of  said  Corporation,  specified  in  the  bill 
of  lading  as  follows: 

DATE  VESSEL  MARKS  AND  NOS.  MERCHANDISE 


and  in  consideration  thereof,  I    (we)   hereby  agree  to  hold  said 
goods  for  the  said  Corporation,  and  as  its  property,  with  liberty 

i  -  •Elements  of  Foreign  Exchange"  by  Franklin  Escher,  p.   151. 

is  Other  examples  of  trust  receipts  may  be  found  in  Margraff's 
"International  Exchange,"  p.  96;  and  in  Brooks'  "Foreign  Exchange 
Text-book,"  p.  177;  and  in  Escher's  "Elements  of  Foreign  Exchange," 
p.  149.  In  the  latter  book,  p.  150,  there  is  also  given  a  specimen 
"bailee  receipt"  of  the  type  taken  by  the  Guarantee  Trust  Company 
of  New  York. 


THE  BANK  CREDIT  AND  LETTER  OF  CREDIT      159 

to  sell  the  same  for  its  account,  but  without  authority  to  make 
any  other  disposition  whatever  of  the  said  goods  or  any  part 
thereof  (or  the  proceeds  thereof)  either  by  way  of  condi- 
tional sale,  sale  on  credit,  pledge,  or  in  any  other  manner  what- 
soever. 

In  case  of  sale  I  (we)  further  agree  to  hand  the  proceeds,  as 
soon  as  received,  to  the  International  Banking  Corporation 

to  apply  against  Bill  No amount dated 

drawn  by accepted  by  me  (us)  payable 

and  for  the  payment  of  any  other  indebtedness  of 

mine  (ours)  to  the  International  Banking  Corporation. 

I  (we)  agree  to  keep  said  goods  insured,  to  their  full  value, 
against  fire,  the  sum  insured  to  be  payable  in  case  of  loss  to  the 
International  Banking  Corporation,  with  the  understanding 
that  the  Corporation  is  not  to  be  chargeable  with  the  Storage, 
Premium  or  Insurance,  or  an}^  other  expense  incurred  on  said 
goods. 

I  (we)  further  agree  that  no  failure  or  omission  on  my  (our) 
part  to  fully  carry  out  any  of  the  provisions  of  this  or  any  similar 
receipt  or  agreement  shall  be  deemed  a  waiver  by  the  Interna- 
tional Banking  Corporation  of  any  of  its  rights  or  remedies 
under  any  of  said  papers,  unless  said  waiver  shall  be  in  writing 
endorsed  hereon  and  signed  by  the  International  Banking 
Corporation. 

The  International  Banking  Corporation  may  at  any  time 
cancel  this  trust  and  take  possession  of  said  goods,  or  of  the  pro- 
ceeds of  such  of  the  same  as  may  then  have  been  sold,  wherever 
the  said  goods  or  proceeds  may  then  be  found;  and  in  event  of 
any  suspension,  or  failure,  or  assignment  for  benefit  of  creditors, 
on  my  (our)  part,  or  of  the  non-fulfillment  of  any  obligation,  or 
of  the  non-payment  at  maturity  of  any  acceptance  made  by 
me  (us)  under  any  credit  issued  by  the  International  Banking 
Corporation  on  my  (our)  account  or  of  any  indebtedness  on 
my  (our)  part  to  said  Corporation,  all  obligations,  acceptances, 
indebtedness  and  liabilities  whatsoever  shall  thereupon  (with  or 
without  notice)  mature  and  become  due  and  payable. 

Dated 


L60  FOREIGN  EXCHANGE 

III.  Under  a  third  plan  of  handling  the  goods,  the  banker 
may  warehouse  them  in  his  own  name,  and  arrange  for 
deliveries  from  time  to  time  to  customers  of  the  importer 
as  the  latter  makes  sales.  Here  the  bank  take  steps  to 
secure  the  proceeds  of  the  sales.  In  the  end  it  accounts 
for  these  to  the  importer,  and  the  surplus  of  their  total  over 
the  amount  due  the  hank  is  returned  to  him  and  represents 
his  commercial  profits. 

IV.  In  the  fourth  place  the  importer  may  obtain  pos- 
-  ssion  of,  and  clear  title  to,  the  goods,  prior  to  the  date 
of  maturity  of  his  contractual  indebtedness,  by  the  simple 
method  of  prepayment  of  this  indebtedness.  This  is  pre- 
cisely what  he  does  in  England  or  another  foreign  country, 
when  he  retires  a  documentary  payment  draft  under  the 
rebate  of  discount  plan  described  some  time  since  (in  §  35). 
In  the  United  States  we  do  not  at  present  have  a  regular- 
ized traffic  in  the  retirement  of  documentary  payment 
drafts,  and  do  not  have  an  open  or  market  retirement  rate 
of  discount.  One  reason  is  that  bills  drawn  on  American 
importers  have  not  heretofore  been  numerous.  With  re- 
spect to  importations  under  letters  of  credit,  it  is  safe  to 
say  that  at  least  in  the  United  States  and  probably  every- 
where in  the  world,  prepayment  of  the  sums  due  the  banker 
on  the  contract  for  the  letter  of  credit  is  rare.  The  im- 
porter usually  contrives  to  pay  the  bank  out  of  the  pro- 
ceeds of  the  sale  of  the  imported  wares  themselves,  and  not 
before  the  receipt  of  these  proceeds.  However,  prepayment 
could  be  arranged  on  the  basis  of  a  rebate  of  interest  to  be 
adjusted  privately  between  the  banker  and  the  merchant. 

§  44.  The  bank  credit  as  a  means  of  financing  a  shipment. 
— An  "advance"  is  present  in  a  commercial  transaction 
whenever  a  buyer  of  goods  is  allowed  to  delay  payment  for 
a  period  after  their  shipment.  We  speak  of  the  "burden" 
of  the  advance  as  being  borne  by  whatever  party  it  is  that 
gives  up  present  value  in  return  for  future  payment.     Most 


THE  BANK  CREDIT  AND  LETTER   OF  CREDIT      1G1 

frequently  this  is  a  money  lender  who  deals  either  with 
the  buyer  or  seller.  But  sometimes  the  seller  himself  as- 
sumes the  burden,  by  delivering  the  goods  and  himself  wait- 
ing for  future  payment.  The  presence  of  an  advance  does 
not  depend  on  the  question  whether  legal  title  passes  at 
the  time  of  the  delivery  of  goods  or  is  withheld  until  pay- 
ment is  made.  Commercially  speaking,  the  disposal  of  the 
legal  title  during  the  period  of  the  advance  is  merely  a 
question  of  security.  The  seller  may  shift  the  burden  of 
the  advance  to  the  money-lender  or  bank  by  drawing  a 
long  bill  of  exchange  on  the  buyer  and  discounting  it,  or  by 
taking  the  buyer's  promissory  note  and  discounting  it. 
Here  the  money-lender  gives  up  present  funds  and  agrees 
to  await  the  deferred  payment  due  from  the  buyer.  In 
many  lines  of  domestic  commerce  in  the  United  States  whole- 
salers are  content  with  mere  book  accounts  against  their 
regular  customers,  and  in  these  cases  the  wholesalers  bear 
the  burden  of  the  advances  themselves,  or  if  they  borrow, 
do  so  merely  on  their  own  general  credit.20  When  the 
seller  is  unwilling  to  give  the  buyer  time  it  is  still  possible 

20  Occasionally  we  hear  of  the  assignment  of  open  accounts  as  a 
means  of  borrowing.  Suppose  A  sells  goods  on  time  to  B,  and 
neither  draws  on  B  nor  receives  B's  note.  A  has  a  hook  claim 
against  B.  B  is  said  to  have  bought  from  A  on  open  account. 
Might  not  A  transfer  his  claim  against  B  for  future  payment  to  a 
banker  in  return  for  a  reduced  present  sum?  Such  a  transfer  would 
be  an  assignment  of  an  open  account.  The  following  is  quoted 
from  an  opinion  of  the  counsel  for  the  Federal  Reserve  Board.  "It 
appears  that  certain  national  banks  located  in  Pennsylvania  desir- 
ing to  accommodate  some  of  their  customers,  who  are  coal  operators, 
have  purchased  written  assignments  of  the  open  accounts  due  to 
such  customers  from  various  railroads."  In  answer  to  the  question 
whether  such  written  assignments  can  be  discounted  by  a  Federal 
Reserve  Bank,  the  counsel  states,  "The  assignment  of  an  open  ac- 
count is  not  negotiable  paper  and  is  not  eligible  for  rediscount  by  a 
Federal  Reserve  Bank  under  the  terms  of  section  13  of  the  Federal 
Reserve  Act."     See  Federal  Reserve  Bulletin  for  May,   1916,  p.  227. 


l.i'j  FOREIGN  EXCHANGE 

for  tlit*  latter  to  obtain  an  advance  and  shift  the  burden  to 
a  bank  by  borrowing  from  such  an  institution,  very  likely 
upon  his  own  promissory  note,  perhaps  with  the  purchased 
goods  pledged  as  collateral.  Generally  speaking,  the  bur- 
den of  a  commercial  advance  is  shifted  around  until  it  rests 
upon  the  shoulders  of  the  commercial  bank.  The  function- 
ary that  carries  this  burden  is  under  recent  usage  said  "to 
finance"  the  venture  which  occasions  it,  or  indifferently  "to 
finance"  the  goods  themselves.  It  is  in  this  sense  that  we 
speak  of  the  London  banks  as  financing  the  American  cotton 
exports,  or  as  financing  American  cotton. 

As  the  reader  must  have  noted,  an  advance  is  present  in 
the  olive  oil  transaction  wdiich  we  have  given  to  illustrate 
the  use  of  the  commercial  letter  of  credit.  For  the  Ameri- 
can importer  pays  for  his  oil,  not  when  it  is  sold  and 
.shipped,  not  even  when  it  is  physically  delivered  to  him 
for  use  or  resale,  but  merelj7-  at  a  set  number  of  days  before 
the  maturity  of  the  drafts  drawn  under  the  letter  of  credit. 
And  the  importer's  delay  in  payment  signifies  that  some 
one  must  be  taking  the  burden  of  an  advance.  But  this 
some  one  is  not  the  Italian  or  selling  merchant,  because,  as 
we  know,  he  manages  to  obtain  lire  for  his  goods  on  the 
date  of  shipment.  It  is  not  the  Italian  bank  to  which  he 
sold  his  draft,  for  this  institution  causes  this  bill  to  be 
discounted  forthwith  in  London,  and  following  this  up  by 
the  sale  of  its  own  exchange,  as  already  explained,  it  is 
thus  enabled  to  make  a  practically  immediate  recovery  of 
the  lire  which  it  has  surrendered  to  the  merchant.21  The 
American  bank  makes  no  advance  because  it  makes  no  out- 
lay of  value  until  the  drafts  are  about  to  fall  due  in  London, 
and  it  provides  for  this  outlay  from  funds  furnished  it  by 
the  importing  merchant  himself.  Neither  does  the  London 
accepting  bank  make  the  advance,  for  its  outlay  is  delayed 

21  But  if  the  Italian  bank  should  decide  to  invest  in  the  shipper's 
long  sterling  draft,  it  would  assume  the  burden  of  the  advance. 


THE  BANK  CREDIT  AND  LETTER  OF  CREDIT      163 

until  its  acceptance  matures,  and  then  is. made  from  funds 
provided  by  the  American  bank. 

Finally  we  come  to  the  money  lender  of  London  who 
discounts  the  acceptance  for  the  correspondent  of  the 
Italian  bank  and  holds  this  paper  till  maturity.  This  per- 
son or  company  pays  out  value  at  the  time  of  purchase  of 
the  acceptance  and  waits  for  reimbursement  until  its  ma- 
turity or  until  a  prior  rediscount.  If  the  bill  is  transferred 
one  or  more  times  during  its  life  a  plural  number  of  money 
advancers  will  share  the  burden  of  waiting,  each  usually 
making  interest  at  some  rate  for  the  period  during  which  he 
has  held  it.  Since  the  person  making  the  advance  is  gen- 
erally outside  the  group  of  functionaries  more  directly  con- 
cerned with  the  letter  of  credit,  and  is  in  any  case  a  party 
who  voluntarily  selects  himself,  we  say  that  the  burden  of 
the  advance  rests  upon  the  "open  money  market"  of  Lon- 
don. One  of  the  striking  features  of  the  system  of  sterling 
credits,  is  its  tendency  to  shift  the  burden  of  vast  numbers 
of  advances,  originating  in  merchandise  traffic  in  all  parts* 
of  the  world,  onto  the  open  money  market  of  London 
However,  London  does  not  carry  this  load  without  aid, 
It  receives  much  help  from  the  other  great  money  capitals 
of  the  world.  This  help  is  negative  whenever  these  other 
capitals  withhold  long  sterling  bills  from  discount  in  Lon- 
don, or  whenever  they  invest  in  these  bills  as  the  saying 
goes.  If  the  Italian  bank  of  our  illustration  should  invest 
in  the  bill  of  the  Italian  Olive  Oil  Export  Company,  it 
would  assume  the  role  of  paying  money  in  advance  and 
awaiting  a  deferred  return  and  no  one  in  London  would 
have  an  opportunity  to  play  this  role.  The  aid  received 
by  the  London  money  market  is  positive  if  outside  capitals 
remit  funds  to  that  market  for  employment  there  in  the 
discount  of  bills.  The  same  cause  which  will  occasion  in- 
vestment in  long  sterling  by  outside  capitals,  will  also  tend 
to  produce  a  movement  of  money  funds  from  them  to  Lon- 


Hi  l  FOREIGN  EXCHANGE 

don.  This  cause  will  be  the  existence  of  lower  interest  or 
discount  rates  abroad  than  in  London,  in  other  words 
"easier  money"  abroad  than  in  London.22 

§45.  The  risk  of  exchange. — A  "risk  of  exchange"  is  a 
chance  taken  in  connection  with  some  mercantile,  stock, 
banking,  or  similar  transaction,  which  involves  settlement 
by  means  of  exchange,  that  the  profits  may  be  affected  by  a 
movement  of  the  rate  of  exchange.  Risks  of  exchange  are 
taken  in  domestic  as  well  as  foreign  commerce  but  are  of 
more  consequence  in  foreign.  When  a  dealer  speculates 
in  exchange  itself,  he  places  himself  in  a  position  where 
his  profits  depend  wholly  upon  the  rise  or  fall  of  the  ex- 
change rate,  so  in  general  he  certainly  takes  a  risk  that  the 
price  of  exchange  may  move  adversely  to  his  interests,  just 
as  he  has  a  chance  that  it  will  move  favorably.  But  the 
term  risk  of  exchange  is  not  usually  thought  of  as  covering 
the  chances  taken  in  an  outright  and  purposeful  speculation 
in  the  price  of  exchange,  but  only  as  signifying  a  chance 
with  respect  to  exchange,  taken  as  an  incident  to  some 
principal  operation  which  is  designed  to  yield  a  profit  de- 
rived from  other  sources  than  exchange  fluctuations,  a  profit 
expected  to  accrue  if  the  exchange  rate  should  stand  still. 
Exports  and  imports  of  merchandise  or  securities  sometimes 
take  place  under  circumstances  involving  a  risk  of  ex- 
change, sometimes  not.  International  borrowing  by  means 
of  drawing  long  bills  on  foreign  bankers,  called  "finance 
bills,"  and  also  investment  in  long  bills,  always  involve  a 
risk  of  exchange.23 

22  Documentary  payment  bills  drawn  on  English  importers  call  for 
special  comment  in  this  connection  because  English  bankers  and 
money  lenders  do  not  discount  this  type  of  draft.  The  foreign  bank 
which  buys  one  of  these  drafts  at  its  point  of  origin  may  neverthe- 
less contrive  to  shift  the  burden  of  the  advance  to  London  by  draw- 
ing its  own  long  draft  against  its  acceptance  account  and  securing 
the  account  with  the  documentary  bill  as  collateral.     Compare  §  94. 

23  But  an  operator  may  hedge  against  a  risk.     Compare  §§  78,  81, 90. 


THE  BANK  CREDIT  AND  LETTER  OF  CREDIT      165 

In  the  illustration  of  the  import  of  oil  from  Italy,  there 
are  two  risks  of  exchange,  both  of  which  are  taken  by  the 
American  merchant,  the  importer.  For  there  are  two  ex- 
change rates  either  of  which  may  move  after  he  has  con- 
tracted to  buy  oil  at  a  fixed  price  in  lire,  whose  movement 
will  affect  his  profits,  by  way  of  affecting  the  final  cost 
of  the  oil  to  him  in  dollars.  These  rates  are  (1)  that  for 
sterling  exchange  in  lire  in  Italy  and  (2)  that  for  sterling 
exchange  in  dollars  in  the  United  States.  The  first  becomes 
determinate  when  the  Italian  merchant  "ships  and  draws" 
and  sells  his  sterling  bill  in  his  country  at  the  rate  of  the 
day. 

The  second  is  fixed  when  the  American  comes,  some 
fifteen  days  before  the  maturity  of  this  bill,  to  deliver  to 
the  American  bank  enough  dollars  to  purchase  bankers' 
sight  drafts  at  the  rate  of  the  day  for  the  number  of  pounds 
required  to  discharge  the  maturing  bill.  As  regards  what 
we  might  call  the  direction  of  the  risks,  (1)  the  cheaper 
sterling  exchange  turns  out  to  be  in  Italy,  the  worse  for  the 
American,  the  importer.  For  the  cheaper  this  exchange  is, 
the  greater  the  quantity  of  it  the  Italian  merchant  will  be 
compelled  to  draw,  in  order  to  obtain  the  predetermined 
sum  of  lire  due  him,  and  thus  the  greater  the  amount  of 
the  sterling  acceptance  for  which  the  American  merchant 
will  have  to  provide  cover.  (2)  The  dearer  sterling  ex- 
change proves  to  be  in  the  United  States  when  our  importer 
comes  to  provide  cover,  the  worse  for  him  because  the 
greater  the  number  of  dollars  the  cover  will  cost.  To  illus- 
trate, suppose  (1)  we  take  two  rates  of  exchange  as  dear 
and  cheap  in  Italy,  namely  25.20  and  25.00  lire  per  pound ; 
and  (2)  two  as  dear  and  cheap  in  the  United  States,  say, 
$4.87  and  $4.84  per  pound.  The  best  combination  for  our 
importer  would  be  sterling  dear  in  Italy,  therefore  at  25.20, 
and  cheap  in  the  United  States,  therefore  at  4.84.  Assum- 
ing a  large  shipment  of  oil,  as  100,000  lire  worth,  and  dis- 


ICC  KOKKHiN    KXCIIAXCK 

regarding  minor  expense,  with  this  combination  the  import 
would  cosl  tin'  American  $19,206.     Thus: 

Anioimt  of  60  day  Bterling  drawn  by  Italian  exporter. £3,968.25 

,1(111,000^25.20) 
( Josi  of  sighl  sterling  to  cover  this $19,206.33 

(3,968.21  X4.Mi 
The  worse  combination  of  rates  would  be  25.00  and  4.87,  and  the 
resuH   this: 
Amount  of  60  day  sterling  drawn  by  Italian  exporter. £4,000.00 

(100.000  h- 25.00) 
Cost  of  sight  sterling  to  cover  this $19,480.00 

(4,000  X  4.87) 

There  is  a  difference  between  the  two  costs  of  $274,  or  about 
Vk°fo  of  either.  The  total  risk  to  profits  then  would  not 
be  so  very  great,  if  the  exchange  rates  concerned  were  con- 
fined within  substantially  the  above  stated  ranges  of  fluctua- 
tion. Risks  of  exchange  have  been  enormous  at  times  in 
history,  especially  in  the  cases  of  paper  or  silver  exchanges 
against  gold,  and  needless  to  say,  the  great  war  had  the 
effect  of  vastly  increasing  them  all  over  the  world,  due  to 
its  breaking  down  the  stability  even  of  gold  exchanges. 

The  risks  of  exchange  in  our  illustration  may  be  differ- 
ently distributed,  but  if  this  is  to  be  the  case  the  terms  of 
sale  and  the  detail  of  the  method  of  settlement  will  have 
to  be  altered.  We  shall  assume  the  necessary  alterations 
merely  for  the  purpose  of  illustrating  further  the  rules  of 
risk  of  exchange.  It  is  to  be  understood  the  conventional 
thing  is  for  the  Italian  to  name  his  price  in  lire,  but  sup- 
pose he  agrees  to  sell  (freight  and  insurance  included)  for 
a  designated  amount  of  sterling,  say,  £3,980,  with  the  un- 
derstanding that  this  is  payable  two  months  after  shipment 
in  the  sense  that  he  is  to  draw  under  a  letter  of  credit 
for  this  sum  in  sixty-day  bills.  In  this  case  the  quantity 
of  sterling  drawn  is  determined  in  advance  and  invariable. 
Therefore,  the  American  ceases  to  be  concerned  in  the  rate 


THE  BANK  CREDIT  AND  LETTER   OF  CREDIT      1G7 

for  sterling  exchange  in  Italy,  because  this  affected  him 
only  by  affecting  the  amount  of  sterling  drafts  for  which 
he  had  to  provide  cover.  The  consequences  of  this  method 
of  making  prices  and  effecting  settlement  is  (a)  the  Italian 
assumes  the  first  of  the  two  risks  of  exchange  that  we  have 
been  discussing,  and  the  rule  is  for  him,  the  cheaper  the 
sterling  is  in  Italy  the  worse  for  him,  this  simply  because 
the  cheaper  sterling  is  the  less  the  number  of  lire  he  finally 
receives  for  the  fixed  sterling  price  at  which  he  has  sold  his 
commodity,  (b)  The  American,  however,  still  carries  the 
second  risk  of  exchange. 

Suppose  the  Italian  should  agree  to  sell  the  oil,  delivered 
in  the  United  States,  for  a  designated  sum  of  dollars. 
Under  any  arrangement  for  his  obtaining  payment,  the 
consequence  would  be  that  he  would  take  whatever  risks  of 
exchange  might  be  involved  and  the  American  would  take 
none. 

§  46.  Advantages  of  the  letter  of  credit  system  summarized. 
— The  letter  of  credit  system  challenges  our  admiration.  It 
provides  d)  a  marvelously  convenient  means  of  payment, 
and  (2)  what  is  a  distinct  thing,  a  means  of  financing  in- 
ternational merchandise  movements,  that  is,  means  of  en- 
abling those  who  move  merchandise  in  international  trade, 
virtually  to  borrow  the  funds  required  for  their  undertak- 
ings at  the  low  rates  of  interest  regularly  prevailing  in  the 
world's  monetary  capitals. 

The  benefits  of  the  system  to  importers  summarized. —  (1) 
An  importer  can  by  means  of  a  letter  of  credit  purchase 
goods  from  foreign  merchants  who  cannot  know  or  rely 
upon  his  own  standing;  and  such  purchases  can  be  made 
where  the  seller  demands  cash  on  shipment.  (2)  Advance 
orders,  that  is,  orders  for  merchandise  for  future  delivery 
may  be  given  and  can  willi  safety  be  acted  upon.  (3)  The 
exporter  cannot  obtain  the  cash  due  him,  and  thus  commil 
the  importer  to  reimburse  the  credit-issuing  bank,  without 


FOREIGN  EXCHANGE 

actually  shipping  the  merchandise.  The  system  of  docu- 
mentary bills  provides  for  this.  That  is  to  say,  it  renders 
this  service  unless  the  exporter  should  commit  fraud  in 
obtaining  and  preparing  the  bill  of  lading  and  other  docu- 
ments. The  possibility  of  this  sort  of  fraud  cannot,  of 
course,  be  wholly  eliminated  by  any  system,  but  the  letter 
of  credil  system  affords  the  importer  the  maximum  of  pro- 
tection practically  possible,  against  the  collection  of  cash  by 
the  exporter  without  his  performance  of  his  part  of  the 
mercantile  transaction,  namely  the  shipment  of  the  goods. 
We  must  bear  in  mind  that  the  importer  becomes  respon- 
sible to  the  credit-issuing  bank  for  the  drafts  drawn  upon 
it,  whether  or  not  the  goods  were  actually  shipped  or  are 
actually  up  to  grade.  (4)  Lastly,  the  system  provides  the 
importer  with  a  means  of  obtaining  the  advances  necessary 
to  move  his  goods,  ultimately  from  the  world's  central 
money  markets,  and  virtually  at  the  comparatively  low 
rates  of  interest  there  prevailing.  It  appears  then  that  the 
importer  who  purchases  commercial  letters  of  credit  from 
his  banker  obtains  adequate  return  indeed  for  the  commis- 
sions he  pays. 

Benefits  of  the  system  to  exporters  summarized. —  (1) 
The  exporter — in  our  illustration,  the  Italian  Olive  Oil  Ex- 
port Compam- — is  enabled  to  obtain  cash  payment  in  full 
for  his  merchandise  as  soon  as  he  ships  it.  (2)  Further- 
more, he  enjoys  this  benefit  with  an  absolute  minimum  of 
secondary  liability  upon  the  draft  which  he  has  drawn  and 
sold.  Since  this  draft  is  specifically  authorized  by  a  bank, 
the  danger  of  its  dishonor  is  reduced  to  an  almost  negligible 
minimum.  On  the  other  hand,  when  an  exporter  arranges 
to  obtain  payment  by  drawing  upon  the  private  importing 
house,  his  secondary  liability  in  case  of  sale  of  the  draft,  is 
by  no  means  always  negligible.  Indeed  in  many  cases  a 
draft  on  an  unknown  house  in  a  distant  country  might 
hardly  be  salable.     That  is,  a  bank  might  refuse  to  take  the 


THE  BANK  CREDIT  AND  LETTER  OF  CREDIT      169 

draft  except  for  collection.  Under  the  letter  of  credit  sys- 
tem neither  the  exporter  nor  his  bank  need  to  know  the 
standing  of  the  buyer  of  the  merchandise.  For  the  engage- 
ment of  the  bank  which  writes  the  letter  of  credit,  to  the 
effect  that  the  drafts  drawn  under  it  shall  be  duly  accepted 
and  paid,  is  not  in  the  slightest  degree  conditional  upon 
the  solvency  of  the  applicant  for  the  letter.  (3)  Another 
advantage  to  the  exporter  is  that,  guarded  by  a  letter  of 
credit  he  may,  upon  the  order  of  the  foreign  buyer,  safely 
start  to  manufacture  or  collect  merchandise  for  subsequent 
shipment.  For  law  and  custom  provide  that,  once  a  letter 
of  credit  is  issued  to  him,  he  may  rightfully  count  upon 
drawing  all  drafts  necessary  to  reimburse  him  for  such  mer- 
chandise as  he  has  prepared,  or  put  into  process  of  prepara- 
tion, to  satisfy  the  order  which  is  supported  by  the  letter 
of  credit.  This  is  true  both  under  (1)  the  absolutely 
irrevocable  credit  and  (2)  the  form  which  gives  the  bank  a 
qualified  right  of  revocation.  In  many  agreements  for 
letters  of  credit  it  is  stated  that  the  bank  may  revoke  the 
credit  "at  any  time  to  the  extent  that  it  shall  not  have  been 
acted  upon  when  notice  of  revocation  is  received  by  the 
user."  This  merely  means  that  when  the  beneficiary  of 
the  credit  receives  notice  of  revocation  he  shall  not  there- 
after make  further  commitments  looking  toward  the  sat- 
isfaction of  his  buyer 's  orders ;  but  that  he  has  a  right  to 
complete  payment  or  reimbursement  for  any  commitments 
which  he  has  already  made. 

§  47.  The  confirmed  credit. — Where  the  drawee  bank  and 
the  bank  which  grants  the  credit  are  different  institutions, 
there  may  arise  what  is  called  the  "confirmed  credit."  In 
the  leading  illustration  which  we  have  been  considering 
these  many  pages,  the  Ilundreth  National  Bank  of  Chicago 
issues  a  letter  authorizing  the  beneficiary,  the  exporter  in 
Italy,  to  draw  upon  the  London  Joint  City  and  Midland 
Bank.     The  exporter  might,  before  preparing  and  shipping 


170  KOKKH1X   KXCIIANGE 

the  goods,  desire  the  London  Joint  City  and  Midland  to 
ratify  the  credit.  This  ratification  will  give  what  is  known 
as  a  confirmed  credit.  Without  confirmation  the  benefi- 
ciary is  in  the  beginning  protected  merely  by  the  engage- 
ment of  the  hank  which  has  written  the  letter  of  credit. 
In  this  case  the  refusal  of  the  drawee  bank  to  accept  the 
draft  authorized,  would  give  the  holder  who  had  taken 
the  draft  on  the  strength  of  the  letter,  an  action  in  con- 
tracts in  his  own  name  but  this  action  or  suit  could  be 
instituted  only  against  the  bank  which  wrote  the  letter  of 
credit.  No  right  of  action  would  exist  in  favor  of  this 
holder  against  the  London  bank  itself  prior  to  its  acceptance 
of  the  draft,  for  this  bank  has  not  bound  itself  in  any  way 
to  the  drawer  or  the  holder.  Possibly  the  London  bank 
might  refuse  to  accept  because  of  some  irregularity  in  the 
American  bank's  conduct  or  arrangement  with  it,  or  per- 
haps because  it  never  had  agreed  to  accept  drafts  for  this 
bank.  These  are  bad  cases,  but  we  are  only  supposing.  Be 
these  things  as  they  may,  the  exporter  sometimes  demands 
a  confirmed  letter  of  credit,  very  likely  because  the  bank 
to  which  he  plaus  to  sell  the  drafts  demands  confirmation. 
Confirmation  is  effected  by  the  drawee  bank's  writing  to  the 
beneficiary  and  engaging  with  him  that  it  will  accept  the 
drafts.  For  this  it  receives  an  extra  commission.  It  writes 
a  contract  to  accept.  The  effect  of  this  is  to  give  the  holder 
of  the  draft  a  right  of  action  in  contracts  against  the 
London  bank  itself,  in  case  the  latter  should  in  fact  subse- 
quently refuse  to  accept  the  instrument.  After  acceptance, 
of  course,  a  draft  under  an  unconfirmed  letter  is  just  as 
good  as  one  under  a  confirmed  letter,  for  after  acceptance 
the  drawee  bank  is  fully  and  unconditionally  bound  to  pay. 
But  the  exporter  has  to  prepare  and  ship  his  goods  before 
acceptance  and  thus  confirmation  is  not  without  significance. 
One  point  is  that  it  gives  a  right  of  action  against  a  bank 
which  is  nearer  the  exporter's  country  (in  European  cases) 


THE  BANK  CREDIT  AND  LETTER  OF  CREDIT      171 

and  generally  better  known  than  the  American  bank,  and 
adds  this  right  of  action  to  the  one  already  existing  against 
the  American  bank.  A  confirmed  credit  is  regarded  as  an 
exceptionally  secure  basis  for  the  manufacture  or  collection 
of  goods  for  export. 

If  the  agreement  of  sale  between  the  merchants  calls  for 
a  confirmed  credit,  the  importer  will  ask  his  bank  for  the 
same  and  pay  an  extra  commission.  This  bank  will  then 
advise  the  drawee  (or  London)  bank  to  issue  the  confirma- 
tion and  will  pay  it  its  commission  for  this  action.  In  the 
majority  of  cases  confirmation  of  the  letters  of  credit  of  our 
bankers  upon  foreign  institutions  is  not  demanded.  It  is 
obvious  that  where  a  bank  issues  a  letter  of  credit  author- 
izing drafts  upon  itself  there  is  no  point  to  a  separate  con- 
firmation. 

§  48.  The  "authority  to  purchase"  and  "authority  to 
draw." — The  bank  credit  serves  chiefly  to  give  assurance 
to  the  exporter  (1)  that  he  will  be  able  to  sell  his  draft 
for  cash  at  the  time  of  shipment,  and  (2)  that  there  will 
be  no  recourse  upon  him,  or  demand  for  reimbursement 
from  him,  in  the  event  of  the  failure  of  the  importer  before 
the  whole  transaction  is  settled  up.  The  importer  pays  the 
costs  of  providing  this  credit  and  under  it  the  exporter 
takes  a  minimum  of  risk.  "We  come  now  to  what  is  known 
to  some  bankers  as  an  "authority  to  purchase,"  which 
issues  at  the  importer's  request  and  at  his  expense  in  com- 
missions, and  for  the  benefit  of  the  exporter,  and  which  is 
in  one  respect,  though  in  one  respect  only,  a  partial  substi- 
tute for  the  bank  credit.  The  plan  of  settlement  through 
the  agency  of  an  authority  to  purchase  is  by  no  means  so 
widely  known  nor  so  important  as  the  bank  credit,  but  it 
resembles  the  latter  in  that  its  design  is  to  give  the  exporter 
assurance  that  he  will  be  able  to  sell  bis  drafl  for  cash  at 
the  time  of  shipment.  The  exporter  is  not  empowered  to 
draw  on  a  bank,  but  draws  directly  on  the  importer,  and 


L72  FOREIGN  EXCHANGE 

thus  creates  what  we  liave  heretofo~e  called  a  mere  trade 
bill.  Bui  the  importer  takes  steps  to  provide  an  assured 
or  virtually  assured  cash  purchaser  for  the  draft.  This 
purchaser  will  lie  a  bank  of  the  importer's  city,  to  which 
the  importer  is  known,  and  not  a  bank  in  the  exporter's 
city.  It  is  true  a  bank  in  the  exporter's  city  will  con- 
summate the  actual  purchase,  but  merely  in  the  capacity 
of  agent  for  the  bank  in  the  importer's  city. 

From  this  point  forward  explanation  will  best  be  pre- 
sented in  the  form  of  an  illustration.  Suppose  the  San 
Francisco  Tea  Company  arranges  to  import  10,000  pounds 
of  a  certain  grade  of  tea  from  an  exporter  of  Canton,  a 
number  of  shipments  to  be  made  within  a  period  of  six 
months,  the  price  being  say  25^,  money  of  the  United  States, 
for  each  pound  delivered  on  the  dock  at  San  Francisco. 
We  may  call  the  exporter  the  Canton  Company.  Against 
any  shipment  the  Canton  Company  will  draw  upon  the 
San  Francisco  Tea  Company  a  draft  in  American  dollars. 
(If  the  Canton  Company's  price  were  such  and  such  a  sum 
of  local  money  of  Canton,  as  would  very  likely  be  the  case, 
the  draft  would  be  drawn  for  a  sufficient  amount  in  dollars 
to  fetch  the  required  sum  of  local  money,  and  the  risk  of 
exchange  would  thus  rest  with  the  San  Francisco  company.) 
In  any  case  the  importer  first  of  all  goes  to  a  San  Francisco 
exchange  bank,  which  we  may  call  the  Bank  for  Foreign 
Trade,  and  asks  it  to  buy  the  Canton  Company's  drafts  at 
their  point  of  origin.  To  induce  the  bank  to  render  this 
service  the  Tea  Company  (1)  agrees  to  pay  a  designated 
commission,  and  (2)  gives  the  bank  a  contract  known  as 
an  "authority  to  draw."  A  specimen  of  the  latter  ap- 
pears immediately  beneath. 


THE  BANK  CREDIT  AND  LETTER  OF  CREDIT      173 

A.  P.  No.  000 

Cabled    


IN  DUPLICATE 

Authority  to  Draw 
(Letter  of  guarantee) 

July  1,  1916. 
BANK  FOR  FOREIGN  TRADE, 

S.  F. 
Dear  Sir: 

We  beg  to  inform  you  that  we  have  authorized  The  Canton  Co. 
to  draw  on  us  with  recourse  to  the  extent  of  $2,500  at  60  days' 
sight  for  full  invoice  cost  against  the  following  documents : 

Bill  of  Lading,  Invoice, 

Insurance  Certificate,  Consular  Invoice, 

to  cover  shipment  of  10,000  pounds  of  tea  from  Canton  to  S.  F. 

and  indorsed  in  blank 


BILL  OF  LADING  TO  ORDER   , 

ot  Bank  tor  1  oreign  Irade. 

Freight  to  be  prepaid.     Marine  Insurance  by  shipper. 
We  agree,  1.  To  accept  on  presentation  all  bills  drawn  pur- 
suant hereto. 

2.  To  hold  the  Bank  for  Foreign  Trade  harmless 
because  of  any  damage  to  merchandise  shipped 
or  deficiency  or  defect  therein  or  in  the  docu- 
ments above  described. 

3.  That  the  said  documents,  or  the  merchandise  cov- 
ered thereby,  and  insurance  shall  be  held  as  col- 
lateral security  for  due  acceptance  and  payment 
of  any  drafts  drawn  hereunder,  with  power  to  the 
pledgee  to  sell  in  case  of  non-acceptance  or  non- 
payment of  the  debt  to  them  attached,  without 
notice  at  public  or  private  sale  and  after  deduct- 
ing all  expenses  including  commissions  connected 
therewith,  the  net  proceeds  to  be  applied  toward 
payment  of  said  drafts.  The  receipt  by  you  of 
other  collateral,  merchandise  or  cash,  now  in 
your  hands,  or  hereafter  deposited,  shall  not  alter 


17  1  FOREIGN  EXCHANGE 

your  power  to  sell  the  merchandise  pledged  and 
the  proceeds  may  be  applied  to  any  indebtedness 
by  us  to  the  Rank  due  or  to  become  due. 
4.  To  pay  your  commission  of  ....  %  for  negotia- 
tion of  drafts  hereunder. 
This  engagement  to  commence  from  date  hereof  and  to  apply 
to  all  Bills  drawn  within  six  months. 

Please  advise  by  mail. 

Yours  faithfully, 

S.  F.  Tea  Co., 

Per  J.  Jones,  Pres.  &  Mgr. 

The  above  is  our  A.  P.  No.  000.     Please  do  the  needful. 

Yours  very  truly, 


Ace-t.  Mgr. 

The  foregoing  is  essentially  a  contract  to  accept,  with 
incidental  provisions.  It  first  confers  upon  a  designated 
party  the  right  to  draw  drafts  upon  the  person  signing  the 
contract,  up  to  a  certain  sum  and  within  a  specified  period, 
and  second,  provides  that  the  drafts  must  be  drawn  against 
shipments  of  a  stated  kind  of  merchandise  and  must  have 
certain  documents  attached,  and  third,  binds  the  person  who 
signs  to  accept  the  drafts  without  regard  to  the  actual  ar- 
rival of  the  merchandise  or  to  its  character  or  condition 
when  it  appears.  In  the  fourth  place,  it  is  agreed  that  the 
bank  shall  have  the  merchandise  as  collateral  security.  The 
commission  to  be  paid  by  the  importer  is  also  stated. 

To  transmit  to  its  branch  or  correspondent  in  Canton  an 
authority  as  agent  to  purchase  the  described  drafts,  the 
importer's  bank  will  commonly  forward  simply  a  copy  of 
the  authority  to  draw  bearing  a  notation  "please  do  the 
needful"  or  words  of  similar  import.  This  becomes  the 
"authority  to  purchase,"  abbreviated  "A.  P."  The  ex- 
porter will  be  notified  in  a  suitable  manner  of  the  existence 
of  this  authority  to  purchase  for  his  benefit.  In  case  of 
necessity  the  authority  may  be  telegraphed. 


THE  BANK  CREDIT  AND  LETTER  OF  CREDIT      175 

The  Authority  to  Purchase  is  by  no  means  so  desirable 
from  the  exporter's  standpoint  as  the  bank  credit,  but  has 
nevertheless  some  advantages.  If  the  Canton  Company  of 
our  illustration  drew  upon  the  San  Francisco  Tea  Com- 
pany without  the  support  of  the  authority  to  purchase 
issued  by  the  San  Francisco  bank,  it  might  not  be  able  to 
sell  its  draft  for  cash.  For  if  the  San  Francisco  company 
should  fail  in  a  business  way  or  should  for  other  reason 
refuse  to  honor  the  draft,  trouble  and  expense  would  be 
occasioned.  The  buying  banker  would  have  no  right  of 
action  against  the  drawee  if  the  latter  refused  to  accept  the 
bill  and  would  have  to  resort  to  the  merchandise  as  collateral 
and  probably  also  to  recourse  upon  the  drawer  for  a  bal- 
ance due  after  the  goods  were  disposed  of  at  forced  sale. 
Doubtless  these  evil  possibilities  would  not  actually  be  real- 
ized in  most  cases,  but  they  are  frequently  of  sufficient 
weight  to  make  a  banker  at  the  point  of  export  refuse  to 
go  further  than  to  receive  the  draft  for  collection,  whereas 
in  general  the  exporter  would  much  prefer  to  make  a  sale 
of  the  instrument.  The  simple  and  single  benefit  of  the 
authority-to-purchase  plan  is  that  the  importer  induces  a 
banker  of  his  city  to  whom  he  is  known  to  purchase  the 
draft  at  the  time  and  place  of  its  origin.  This  banker  acts 
primarily  because  he  knows  and  has  confidence  in  the  im- 
porter, and  secondarily  because  he  is  also  fortified  by  the 
latter 's  engagement  to  accept  the  draft  without  conditions 
as  to  the  arrival  and  .sufficiency  of  the  goods.  This  banker 
would,  in  the  event  of  the  refusal  of  the  drawee  to  accept, 
have  three  channels  of  reimbursement  open  to  him  for  his 
outlay  for  the  draft  and  his  charges,  namely,  (1)  an  action 
against  the  drawee  on  the  latter 's  contract  to  accept,  (2) 
resort  to  a  sale  of  the  goods,  and  (3)  recourse  upon  the 
drawer.24     The  banker  will  not,  however,  issue  an  authority 

24  The  contract  of  the  drawee  to  accept  does  not  operate  to  destiny 


L76  FOREIGN  EXCHANGE 

to  purchase  for  an  importer  where  lie  thinks  there  is  any 
appreciable  danger  that  the  latter  will  fail  to  honor  the 

draft. 

If  we  suppose  the  Canton  Company  to  make  a  shipment 
to  the  value  of  $500  and  to  draw  a  draft  for  this  amount 
upon  the  San  Francisco  Tea  Company,  the  following  would 
be  the  regular  course  of  events.  The  Bank  for  Foreign 
Trade  of  San  Francisco  would  through  its  agent  buy  the 
draft  in  Canton.  The  instrument  would  be  forwarded 
immediately  to  San  Francisco  and  would  be  presented  to 
the  San  Francisco  Tea  Company  for  acceptance,  which 
would  be  granted.  The  goods,  upon  arrival,  might  be  re- 
leased to  the  acceptor  under  any  of  the  several  plans  already 
discussed  in  §  43. 

§  49.  The  practical  nature  of  the  right  of  recourse. — By 
way  of  comparison  of  the  bank  credit  and  the  authority  to 
purchase,  the  following  may  be  noted.  (1)  The  ordinary 
commercial  letter  of  credit  is  a  communication  from  a  bank 
to  the  beneficiary  and  is  designed  to  be  shown  by  this  person 
as  a  credential  to  any  banker.  In  regular  practice  the 
banker  to  whom  the  exporter  carries  his  letter  of  credit, 
takes  his  draft  as  an  outright  purchase  made  on  his  own 
account.  On  the  other  hand,  the  authority  to  purchase 
is  a  communication  direct  to  a  particular  bank,  requesting 
it  to  buy  the  draft  of  the  beneficiary,  and  in  this  business 
to  act  as  the  agent  of  the  bank  sending  the  authority.  (2) 
Under  the  letter  of  credit  the  beneficiary  draws  upon  a 
bank,  under  the  authority  to  purchase  upon  the  importing 
merchant.  Documents  are  attached  to  the  draft  in  either 
case.  (3)  Unless  there  is  a  clause  permitting  revocation, 
bankers  understand  that  the  commercial  letter  of  credit  is 
irrevocable,  whereas  they  understand  that  the  authority 
to    purchase    is    revocable    at    any    time    prior    to    the 

the   right   of   recourse   upon   the   drawer    in   the   event   of    dishonor 
whether  for  non-acceptance  or  for  non-payment. 


THE  BANK  CREDIT  AND  LETTER   OF  CREDIT      177 

actual  purchase  of  the  draft  by  the  foreign  bank  acting 
as  agent.  An  occasion  for  such  revocation  might  be,  for 
instance,  the  business  failure  of  the  importing  merchant 
after  he  has  arranged  for  the  authority  to  purchase  but 
before  the  exporter's  draft  is  actually  bought.25  (4)  The 
practical  nature  of  the  liability  of  the  exporter  to  recourse, 
as  drawer  of  the  draft,  is  very  distinct  under  the  authority 
to  purchase  as  compared  with  the  bank  credit. 

The  trade  bill,  drawn  on  the  importer  instead  of  a  bank, 
is  essentially  the  same  whether  supported  by  an  authority 
to  purchase  or  not.  In  either  case  failure  of  the  importer 
to  honor  the  draft  means  recourse  upon  the  drawer,  unless 
the  latter  should  enjoy  the  rare  advantage  of  having  the 
goods  sell  for  enough  to  discharge  the  draft.  An  authorized 
draft  on  a  bank  is  distinct  in  that  the  failure  of  the  im- 
porter to  pay  does  not  involve  recourse  iipon  the  exporter 
as  drawer.  As  has  been  stated  before,  the  undertaking  of 
a  bank  which  grants  a  credit,  that  the  draft  will  be  accepted 
and  paid,  is  not  conditioned  upon  the  solvency  of  the  im- 
porter or  the  performance  of  his  obligations,  but  is  absolute 
after  the  exporter  has  drawn  his  draft  in  accordance  with 
instructions.  The  bank  granting  the  credit  takes  all  the 
risk  that  the  importer  will  fail,  and  the  exporter  is  wholly 
relieved  of  this  risk.  Bankers  issuing  authorities  to  pur- 
chase take  pains  to  make  it  clear  to  merchants  that  the 
drawer  is  subject  to  recourse  in  the  event  of  the  failure  of 
the  importer  to  accept  or  to  pay,2G  and  regard  this  as  a  Lead- 
ing point  of  distinction  between  the  authority  to  purchase 
and  the  true  bank  credit. 

Before  quitting  this  subject  it  is  desirable  to  make  clear, 
however,  that  the  actual  legal  righl   of  recourse  upon  the 

-■"'With  regard  to  the  revocation  of  a  commercial  letter  of  credit 
see  §  41. 

26  Compare  the  words  "with  recourse"  in  the  second  line  of  the 
main  body  of  the  specimen  authority  to  draw  given  on  p.  173. 


178  FOREIGN  EXCHANGE 

drawer  is  present  in  the  ease  of  the  draft  under  a  bank 
credil  just  as  it  is  in  the  case  of  the  draft  on  the  importer 
in  person.  The  truth  is,  not  that  the  right  of  recourse  is 
(lest  roved  in  the  case  of  the  bank  credit,  but  rather  that  its 
practical  nature  is  entirely  altered.  As  shown  in  §12  of 
this  book,  the  right  of  recourse  emerges  with  (1)  proper 
presentment  to  the  drawer,  (2)  dishonor,  and  (3)  due  no- 
tiee  of  dishonor  (including  protest  as  a  necessary  element 
in  the  case  of  foreign  bills,  unless  waived).  Suppose  the 
Canton  Company  of  our  illustration  were  granted  a  credit 
at  the  importer's  request  by  a  San  Francisco  bank  and  sold 
its  draft  upon  this  bank  to  a  banker  of  Canton.  If  the 
San  Francisco  bank  should  fail  or  should  for  other  reason 
dishonor  this  draft,  the  banker  of  Canton  could  have  re- 
course upon  the  Canton  Company  as  drawer.  The  fact  that 
the  drawee  was  a  bank,  and  that  it  had  contracted  to  accept 
and  pay  the  draft,  has  no  effect  on  the  right  of  recourse. 
The  difference  between  an  authorized  draft  on  a  bank  and 
a  draft  on  the  importer  (whether  an  authority  to  purchase 
the  latter  issues  or  not)  from  the  standpoint  of  the  exporter 
as  drawer  is  clear.  He  is  subject  to  a  legal  right  of  re- 
course in  both  cases,  but  in  the  instance  of  the  bank  credit 
it  will  require  a  failure  of  the  drawee  hank  to  bring  recourse 
upon  him,  and  the  failure  of  the  importer  will  not  bring  it. 
The  importer  is  not  the  drawee  in  this  instance.  In  the 
case  of  the  trade  bill  the  failure  of  the  importing  house 
alone  is  sufficient  to  produce  recourse.  There  is  a  great 
practical  difference  in  the  two  risks.27 

-'  The  acceptance  by  a  bank  of  a  long  bill  drawn  upon  it  by  a  mer- 
chant does  not  remove  the  possibility  of  recourse  upon  him  as 
drawer  in  the  event  of  non-payment.  The  certification  (acceptance) 
of  a  check  by  a  bank  does  release  the  drawer,  but  this  is  a  distinct 
case.  If  A  draws  a  check  on  a  bank  payable  to  B,  and  if  B  for  his 
own  reasons  takes  a  certification  of  the  check  at  the  bank's  counter, 
the  effect  is  to  destroy  B's  right  of  recourse  upon  A  as  well  as  upon 
any   indorsers.     B  has  had  an   opportunity   to  demand  payment  of 


THE   BANK  CREDIT  AND  LETTER   OF  CREDIT       179 

§  50.  The  commissions  charged  for  bank  credits. — Im- 
porters who  apply  for  bank  credits  pay  the  institutions 
that  issue  them  commissions  for  the  service  thus  rendered. 
Such  a  commission  is  a  matter  of  private  adjustment  be- 
tween banker  and  customer  and  will  vary  to  a  considerable 
degree  according  to  the  character  of  the  firm  that  is  accom- 
modated. There  are,  however,  certain  average  or  standard 
commissions  found  in  ordinary  practice,  and  a  table  of  the 
charges  levied  by  American  bankers  for  the  issue  of  credits 
is  presented  beneath.  A  noteworthy  feature  of  this  class 
of  commission  is  that  it  is  roughly  proportional  to  the 
length  of  life  or  usance  of  the  drafts  that  are  to  be  drawn 
under  the  credit. 

The  following  may  be  taken  as  standard  or  full  commis- 
sions charged  by  American  banks  to-day: 


For 

For 

Sterling  Credits 

Dollar  Credits  Granted 

On  London  Bankers 

By 

the  Bank  on  Itself 

Per  cent. 

Per  cent. 

Drafts  at  sight 

Vi  to    y2 

%  to  Vi 

Drafts  at  30  days 

%  to     % 

V*  to  % 

Drafts  at  60  days 

y2  to  % 

%  to  & 

Drafts  at  90  days 

%  to     % 

%  to  % 

Drafts  at  4  mos. 

%  to  1 

%  to  % 

Drafts  at  6  mos. 

1      to  V/s 

%  to  % 

Concessions  from  these  rates  are  not  infrequently  made  in 
favor  of  houses  of  excellent  standing  that  have  large  and 
regular  dealings  with  a  bank. 

the  instrument,  since  it  is  due  at  sight,  and  he  cannot  forego  this 
opportunity  and  also  hold  the  parties  secondarily  liable. 

If  13  holds  a  sight  draft  upon  a  private  person  as  distinguished 
from  a  bank,  and  if  he  accepts  some  undertaking  of  that  person  in 
place  of  payment  itself  of  the  draft,  this  undertaking  being  anal- 
ogous to  certification  by  a  bank,  this  action  by  B  will  release  the 
parties  secondarily  liable  from  all  further  liability  in  the  sami 
manner  as  certification  by  a  bank. 


L80  FOKKKJX   K.XCll  A\(iK 

A  London  bank's  charge  for  confirming  a  credit  issued 
againsl  it  by  an  American  correspondent  will  ordinarily 
run  Prom  '-"  to  '*  of  mm  per  cent.  Usually  this  charge  is 
independenl  of  the  Length  of  life  of  the  drafts  to  be  drawn. 
It  will  lie  assessed  against  the  American  bank  in  sterling, 
ami  its  equivalent  in  dollars  will  be  collected  by  the  latter 
institution  from  the  applicant  for  the  confirmed  credit. 

The  question  of  how  much  commission,  or  whether  any 
commission,  is  to  be  charged  for  the  issue  of  an  "authority 
to  purchase,"  is  so  much  a  matter  of  special  adjustment 
between  banker  and  customer  that  a  table  of  standard  com- 
missions for  this  service  can  hardly  be  presented. 

The  London  bank  or  accepting  house  which  accepts  drafts 
drawn  upon  it  under  the  authorization  of  an  American  cor- 
respondent will  in  all  cases  demand  a  compensation  in  one 
form  or  another  for  this  lending  of  its  name.  The  usual 
form  taken  by  this  compensation  is  a  commission,  of  per- 
haps Vig  of  1%  for  each  month  of  life  of  each  draft  accepted. 
For  example,  on  a  90  days'  draft  for  £10,000,  the  London 
acceptor  would  at  this  rate  charge  3/w  of  1%  of  £10,000, 
or  £18.75  (that  is,  £18  and  15  shillings).  On  this  same 
draft  the  American  bank  might  collect  from  the  applicant 
for  the  credit  a  commission  of  perhaps  %  of  1%,  and  out 
of  this  would  pay  the  London  banker's  acceptance  com- 
mission, which  would  take  something  less  than  half  of  the 
amount  so  collected.  Commissions  are  assessed  on  the 
drafts  drawn  and  not  upon  the  total  aomunt,  or  maximum 
limit,  of  the  credit  itself.  The  American  banker  pays  com- 
missions due  the  London  house,  in  sterling,  and  collects  com- 
missions from  the  importer  in  dollars.  It  is  said  that  some- 
times the  American  and  London  banks  conduct  their  busi- 
ness in  sterling  credits  on  joint  account,  which  signifies 
that  they  divide  equally  the  commissions  collected  from  the 
applicants  for  such  credits. 

The  fact  that  the  commission  charged  for  drafts  drawn 


THE  BANK  CREDIT  AND  LETTER   OF  CREDIT      181 

under  bank  credits  is  a  function  of  time — that  is,  varies 
roughly  in  proportion  to  the  length  of  life  of  the  draft, 
or  the  time  to  run  between  its  acceptance  and  payment — 
gives  this  commission  a  certain  superficial  resemblance  to 
an  interest  charge.  Thus  a  charge  of  3A%  on  drafts  at 
ninety  days'  sight  is  in  a  sense  a  charge  at  the  rate  of  3% 
a  year.  But  these  commission  rates  are  not  in  the  least 
interest  rates.  The  institutions  collecting  them  make  no 
advances  of  money  or  of  money's  worth  for  a  deferred 
return,  but  as  already  shown  merely  "lend  their  credit" 
(which  means  to  become  liable),  whereas  a  real  advance 
for  a  deferred  return  must  be  present  to  give  rise  to  what 
is  known  as  interest  and  a  rate  of  interest. 

The  banker  who  issues  a  credit  becomes  unconditionally 
liable  for  the  payment  of  the  drafts  drawn  under  it.  He 
takes  the  risk  that  the  importer  who  has  applied  for  the 
credit  may  suffer  business  failure  before  the  time  arrives 
when  he  is  obligated  to  reimburse  the  bank  for  the  drafts 
drawn.  The  banker  also  renders  this  importer  a  valuable 
service.  It  is  for  this  risk  and  service  that  the  commission 
is  charged.  The  reason  why  the  commission  is  made  greater 
as  the  length  of  life  of  the  drafts  is  increased,  is  because 
the  longer  this  life  the  greater  is  the  length  of  time  during 
which  the  importer  may  postpone  reimbursement  and  the 
longer  is  the  period  during  which  the  banker  carries  the 
risk  of  his  solvency.  The  importer  engages  to  reimburse 
the  bank  a  fixed  number  of  days  prior  to  the  maturity  of 
the  acceptances.  Obviously  if  the  drafts  run  at  90  days' 
.sip lit  there  will  be  30  days  more  delay  open  to  the  importer 
than  if  they  run  at  60  days'  sight.  The  risk  carried  by  the 
banker  is  a  rough  function  of  time,  and  it  is  for  this  reason 
commissions  are  approximately  proportional  to  time. 

§  51.  The  traveler's  letter  of  credit  and  the  traveler's 
cheque. — Persons  intending  to  l  ravel  abroad  may  make  ar- 
rangements with  banks  in  the  home  country,  or  with  express 


L82  FOREIGN  EXCHANGE 

companies  or  tourist  agencies,  which  will  enable  them  to 
procure  the  local  money  of  any  foreign  country  visited. 
The  traveler  either  pays  out  home  money  in  advance  or 
gives  the  bank  or  institution  accommodating  him  a  contract 
obligating  him  to  make  payment  later.  There  are  two 
plans  open  to  him.  He  may  procure  what  is  known  as  a 
circular  letter  of  credit,  or  he  may  buy  so-called  traveler's 
cheques.  It  is  true  yet  another  course  may  be  followed, 
for  he  may  carry  abroad  actual  home  money  (preferably 
standard  coin  or  governmental  notes  or  certificates)  and  sell 
it  from  time  to  time  for  the  local  money  of  places  visited, 
but  this  plan  is  neither  so  safe  nor  so  convenient  as  either 
of  those  involving  the  aid  of  the  home  banker,  and  on  the 
average  will  probably  work  out  to  be  more  costly  in  home 
funds  for  a  given  amount  of  foreign  money  secured. 

The  traveler's  letter  of  credit  is  an  instrument  addressed 
by  a  bank  as  a  circular  letter  to  its  correspondents  scattered 
throughout  the  world  informing  them  that  the  traveler  or 
beneficiary  is  authorized  to  draw  sight  drafts  up  to  a  certain 
total  amount  specified,  either  (1)  upon  the  writer  bank 
itself  or  (2)  upon  some  one  of  its  correspondents  named 
in  the  letter,  usually  one  in  London.  The  letter  requests 
the  bankers  addressed,  on  application  to  do  the  beneficiary 
the  favor  of  buying  his  drafts,  that  is  of  exchanging  local 
currency  for  them  at  the  current  rates  of  exchange,  and 
also  conveys  the  writer  bank's  engagement  that  these  drafts 
will  be  paid  by  the  drawee  upon  demand.  Before  the  war 
at  least,  the  vast  majority  of  traveler's  letters  of  credit 
issued  by  American  banks  authorized  sterling  drafts,  or 
drafts  on  London  banks.  As  in  the  case  of  the  commercial 
letter  of  credit,  drafts  as  drawn  and  sold  are  recorded  on 
an  appropriate  page,  and  when  the  last  draft  exhausts  the 
credit,  the  letter  will  be  taken  up  by  the  bank  cashing  it 
and  forwarded  along  with  the  draft  to  be  surrendered  to  the 
drawee  bank.     As  the  traveler  who  carries  a  sterling  letter 


THE  BANK  CREDIT  AND  LETTER  OF  CREDIT   183 

of  credit  goes  about  he  sells  sterling  exchange  according 
to  his  needs  to  procure  local  money  in  the  various  places 
he  visits.  The  letter  of  credit  serves  as  an  introduction  to 
and  as  credentials  before  the  buying  banker.  The  latter 
will  possess  specimen  signatures  of  the  officers  of  the  bank 
which  has  written  the  letter  and  judges  of  the  genuineness 
of  the  individual  letter  presented  at  his  counters  by  an 
inspection  of  the  signatures  which  it  bears  as  well  as  by 
looking  to  its  general  form.  The  banker  will  judge  of 
the  genuineness  of  the  traveler  himself,  so  to  speak,  by 
requiring  him  to  duplicate  a  specimen  signature  which  he 
himself  was  required  to  place  upon  the  letter  at  the  time 
of  its  delivery  to  him,  or  else  upon  a  separate  letter  of 
identification.  The  purpose  of  having  the  latter  document 
distinct  is  safety.  The  traveler  is  advised  to  keep  the  two 
letters  apart.  The  loss  of  one  alone  would  not  enable  the 
finder,  if  inclined  to  forgery,  to  realize  upon  the  credit. 
The  traveler  is  given  a  list  of  banks,  astonishingly  numer- 
ous, which  will  buy  his  drafts.  This  list  is  obtained  by  the 
institution  writing  the  letter,  from  its  London  correspond- 
ent, and  usually  includes  all  the  banks  in  the  four  corners 
of  the  world  which  already  have  established  relations  with 
this  London  bank.28  Only  larger  banks  and  banking  houses 
sell  their  own  letters  of  credit  whether  these  authorize 
drafts  upon  themselves  or  upon  correspondents.  Many 
smaller  banks  have  arrangements  with  these  larger  institu- 
tions enabling  them  to  issue  letters  as  virtual  agents  of  the 
latter. 

When  a  traveler  pays  cash  in  advance  for  a  sterling  credit 
purchased  from  an  American  bank,  he  is  charged  for  the 
full  face  value  of  the  credit  at  the  "posted  rates"29  for 
sterling  exchange,  and  he  also  pays  a  commission  which, 
as  stated  by  one  banker,  may  be  "anything  or  nothing." 

28  Compare  MargraflF,  "International  Exchange,"  p    73. 
20  Compare  §  24,  p.  82. 


is  I  FOREIGN  EXCHANGE 

Margraff  and  Brooks  place  the  prevailing  commission  at 
It",  to  consider  an  example,  the  posted  rate  is  4.88 
and  the  (•.iniuiissi.il)  \' ',  ,  a  circular  letter  for  £1,000  would 
cosl  $4,880  plus  $48.80  commission,  or  $4,928.80.  Assuming 
the  traveler  uses  this  credit  to  procure  French  money  in 
Paris,  the  number  of  francs  obtainable  per  pound  of  draft 
will  depend  on  the  Parisian  banker's  buying  rate  for  the 
type  of  bill  the  traveler  has  to  sell.  The  cost  of  francs  in 
dollars  would  be  computed  as  follows: 

French  hankers  buying  rate   (say) 25.00  francs  per  £. 

Cost  in  dollars  of  £1  of  the  credit $4.9288 

(4D28.80   [as  shown  above]  ^1000) 
Cost  in  dollars  of  the  25.00  francs  obtained 

from  £1 $4.9288 

Cost  of  1  franc 197t1oo  cents. 

(4.9288-^25) 
Number  of  French  units  obtained  for  $1 .  . .  5.07  -f-  francs. 

(25.00 -h  4.9288) 

If  the  traveler  comes  home  without  having  exhausted 
the  credit  he  will  obtain  dollars  for  the  part  that  remains 
by  selling  it  to  the  bank  which  wrote  the  letter  of  credit 
at  the  latter 's  buying  rate  of  the  day  for  small  sterling 
drafts.  Traveler's  credits  are  often  issued  against  the 
;!i:i  cement  of  the  beneficiary  to  furnish  funds  as  required 
to  cover  the  drafts  drawn,  both  with  and  without  the  de- 
posit of  collateral  security  to  protect  this  engagement.31 

The  London  bank  upon  which  the  traveler's  drafts  are 
drawn  under  a  credit  issued  by  an  American  bank,  reim- 
burses itself  as  fast  as  it  pa}Ts  these  drafts  by  making  im- 
mediate deductions  from  the  deposit  of  the  American  bank 

30  Margraff,  "International  Exchange,"  p.  86;  and  Brooks,  "For- 
eign Exchange  Text  Book,"  p.  140. 

si  For  a  more  detailed  discussion  of  the  traveler's  credit  the  reader 
may  see  Margraffs  '"International  Exchange,"  Chapter  XII,  pp. 
73-87. 


THE   BANK  CREDIT  AND  LETTER   OF  CREDIT       185 

for  the  amounts  thus  paid  out  plus  its  commissions  for 
the  service.  Immediate  reimbursement  is  taken,  of  course, 
because  the  drafts  are  drawn  and  paid  at  sight.  An  Ameri- 
can bank  will  in  regular  course  be  under  the  necessity  of 
buying  and  remitting  sterling  to  the  credit  of  its  London 
balance  against  its  sales  of  travelers'  sterling  credits.  If 
it  conducts  this  department  of  its  business  at  a  profit,  this 
profit  will  flow  from  its  charging  the  buyers  of  credits  more 
dollars  than  are  required  to  purchase  the  cover.  The 
profit  will  come  in  part  from  the  high  posted  rates  charged 
and  in  part  from  the  commissions. 

The  Traveler's  Cheque. — A  comparatively  recent  and 
very  popular  instrument  is  the  "traveler's  cheque."  This 
consists  in  a  sight  draft  drawn  not  by  the  traveler  himself, 
as  under  the  plan  of  the  circular  letter  of  credit,  but  drawn 
by  a  bank  to  the  order  of  the  traveler  as  payee.  Arrange- 
ments are  made  for  the  encashment  of  this  type  of  check 
in  local  money  by  correspondent  banks  and  also  other 
offices  scattered  through  the  leading  countries  of  the  world. 
The  following  is  a  specimen. 


i-.-i.Tfc-i-I.TV.'-C, 


Two  features  distinguish  this  instrument  from  an  ordinary 
cashier's  check  or  sight  bank-draft  made  payable  to  the 
person  who  purchases  it.  (1)  The  traveler's  check  carries 
a  specimen  signature  of  the  payee  which  he  is  required  to 
place  upon  it  at  the  time  of  purchase.     His  ability  to  dupli- 


186  FOREIGN  EXCHANGE 

rate  this  at  the  time  lie  cashes  the  check  serves  to  identify 
him  anywhere  as  the  proper  payee.  "When  a  person  cashes 
an  ordinary  check  or  draft  payable  specially  to  him,  rather 
than  to  bearer,  he  must  indorse  it.  AVhen  the  payee  cashes 
a  traveler's  check  he  really  indorses,  but  the  signature  of 
indorsement  is  in  the  case  of  the  commoner  forms  located  on 
the  face  instead  of  the  back  of  the  instrument,  and  is  called 
a  "counter-signature."  (2)  In  obtaining  cash  on  an  ordi- 
nary sight  draft  in  a  place  foreign  to  the  country  where  the 
draft  was  drawn,  the  draft  must  be  sold  at  the  exchange 
rate  of  the  day,  which  is  a  variable.  The  traveler's  check 
is  cashed  in  a  number  of  leading  countries  for  fixed  and 
invariable  sums  of  local  money  indicated  plainly  on  the 
face  of  the  instrument.  Thus  the  check  shown  above,  which 
may  be  encashed  for  $20  in  the  United  States  or  Canada, 
will  be  encashed  in  Germany  at  a  vast  number  of  offices 
for  83.30  marks,  irrespective  of  the  position  of  the  rates 
of  exchange  in  Germany  on  London  or  New  York,  without 
deduction  for  commission  or  other  account  except  for  any 
local  stamp  tax  on  the  instrument.  This  statement  holds 
good,  of  course,  only  on  the  assumption  of  times  of  peace 
and  the  restoration  of  currency  systems  to  the  positions 
they  occupied  prior  to  the  war.  One  who  carries  traveler's 
checks  takes  no  risk  of  exchange  with  respect  to  encashment 
in  the  several  leading  countries.  In  countries  where  a 
designated  sum  is  not  payable  on  the  check  it  is  to  be  sold 
as  New  York  or  London  exchange,  according  to  which, 
sale  is  the  more  favorable. 

The  banks  which  issue  these  instruments  make  arrange- 
ments for  their  encashment,  in  general  with  the  same  list  of 
banks  as  that  to  which  they  address  their  circular  letters 
of  credit.  In  addition,  however,  many  hotels,  offices  of 
tourist  bureaus,  and  even  railway  ticket  offices  and  ordi- 
nary stores,  receive  the  leading  kinds  in  payment,  and 
sometimes  also  cash  them.     The  system  by  means  of  which 


THE  BANK  CREDIT  AND  LETTER   OF  CREDIT      187 

the  bank  issuing  the  traveler's  check  reimburses  the  bank 
which  cashes  it,  is  necessarily  somewhat  different  in  detail 
from  that  which  prevails  in  the  case  of  the  draft  under  a 
circular  letter  of  credit.  For,  in  cashing  the  latter,  a  for- 
eign bank  merely  buys  it  as  so  much  exchange,  and  pro- 
cures compensation  for  handling  it  by  paying  a  low  enough 
price  for  it.  Since  the  bank  which  cashes  the  traveler's 
check  must  pay  out  a  fixed  sum  of  local  money,  machinery 
must  be  provided  by  means  of  which  the  issuing  bank  may 
directly  or  indirectly  place  in  its  hands  a  suitable  com- 
mission for  his  services. 

The  most  important  traveler's  check  sold  in  the  United 
States  to-day  is  the  one  issued  under  the  auspices  of  the 
American  Bankers'  Association,  which  is  the  one  we  have 
given  as  a  specimen.  A  number  of  larger  banks  in  the 
country,  however,  issue  their  own  traveler's  checks,  and 
also  dispose  of  them  in  part  through  smaller  interior  banks 
as  sales  agents.  The  leading  express  companies  likewise 
put  forth  this  form  of  exchange,  and  in  fact,  as  Mr.  Brooks 
tells  us,  the  American  Express  Company  originated  the 
instrument.32  Under  the  standard  terms  these  checks  are 
in  this  country  sold  for  their  face  value  in  dollars  plus  a 
commission  of  M.>  of  1%,  or  50  cents  per  $100  worth,  in  some 
cases  with  a  minimum  commission  of  50  cents. 

Speaking  of  the  technical  form  of  these  instruments,  the 
majority  of  them  are  real  checks  drawn  by  a  bank  upon 
another  bank  in  favor  of  the  purchaser,  but  some  are  strictly 
demand  promissory  notes  of  the  bank  of  issue,  though  they 
are  still  called  "cheques."  The  precise  technical  form  of 
the  instrument  makes  absolutely  no  practical  difference  in 
its  use.  The  American  Bankers'  Association  check  is  drawn 
by  the  bank  which  sells  it  upon  the  Bankers'  Trust  Com- 
pany of  New  York,  and  bears  the  acceptance  of  the  latter 

32  Brooks,  "Foreign  Exchange  Text  Book,"  p.  lo'.i. 


L88  FOREIGN  EXCHANGE 

institution,  this  acceptance  having  been  placed  upon  the 
instrument  in  advance  when  it  was  a  blank  form  sent  to  the 
selling  bank.33 

77) <  bank  post  remittance  is  a  form  utilized  chiefly  by 
European  immigrants  to  the  United  States,  as  a  means  of 
sending  money  back  to  the  old  countries  for  parents  or 
dependents.  The  latter  are  commonly  a  class  of  persons 
who  would  find  difficulty  in  cashing  ordinary  bank  checks 
or  drafts.  Therefore,  bankers  in  this  country  who  sell  the 
form  of  exchange  known  as  the  post  remittance,  undertake, 
in  return  for  dollars  received  from  the  purchaser,  to  have 
a  foreign  correspondent  bank,  practically  always  one  located 
in  the  country  of  the  designated  payee,  send  the  latter  the 
amount  of  his  home  money  which,  considering  the  banker's 
charges,  is  the  equivalent  of  the  dollars  paid  over  by  the 
purchaser.  The  correspondent  bank  forwards  this  money 
to  the  payee  generally  by  sending  him  local  bank  notes 
tli rough  registered  and  insured  mail,  or  sometimes  by  send- 
ing him  a  local  postal  money  order.  The  purchaser  of  the 
post  remittance  makes  out  an  application  which  commonly 
bears  explanations  in  some  ten  or  twelve  languages,  and 
then  pays  in  his  dollars  and  obtains  a  receipt  to  be  retained 
by  himself,  and  also  a  memorandum,  likewise  ornamented 
by  the  script  of  many  tongues,  which  he  is  to  mail  to  his 
payee  abroad.  The  receipt  specifies  the  address  of  the 
paj-ee,  the  amount  of  his  home  money  he  is  to  receive,  the 
rate  of  exchange  at  which  this  money  is  sold  the  purchaser, 
the  charges  for  transmission  and  minor  expense,  and  the 
total  number  of  dollars  charged  for  the  remittance.  The 
memorandum  sent  by  the  purchaser  to  be  the  payee  is  in 
no  sense  a  check  or  order,  but  is,  technically  speaking, 
simply  an  advice. 

To  sell  a  post  remittance  in  its  own  right,  a  bank  must 


33  Under  the  general  law  of  bills,  acceptances  in  advance  are  valid. 


THE   BANK  CREDIT  AND  LETTER   OF  CREDIT      189 

simply  have  funds  with  or  send  funds  to  the  foreign  bank 
which  it  has  directed  to  forward  money  to  the  payee,  or 
else  it  must  have  relations  with  this  foreign  bank  which 
enable  the  latter  to  obtain  reimbursement  for  its  expendi- 
tures and  services  in  some  appropriate  manner,  as,  for 
instance,  by  drawing  on  the  American  bank's  London  cor- 
respondent a  draft  which  is  to  be  protected  by  the  American 
bank's  advising  London  to  honor  it.  International  money 
orders,  whether  issued  by  the  government,  by  express  com- 
panies, or  by  banks,  are  also  a  form  of  foreign  exchange. 


CHAPTER  VIII 
FOREIGN  MONEY  MARKET  FACTORS 

§  52.  The  foreign  balance. — In  entering  now  upon  the 
general  subject  of  practical  dealing  and  rate  making,  it 
must  be  said  it  will  hardly  be  our  undertaking  to  explain 
each  and  every  form  of  operation  in  exchange  known  to 
actual  practice.  We  shall,  however,  try  to  make  clear  the 
more  important  or  standard  types.  Such  of  these  as  involve 
exchange  investment,  borrowing,  speculation,  or  arbitrage 
will  be  considered  in  special  chapters.  In  pursuance  of  the 
plan  already  laid  down,  attention  will  be  directed  in  the 
main  to  (1)  operations  conducted  by  American  bankers 
(2)  in  sterling  exchange  (3)  under  conditions  prevailing 
just  prior  to  the  present  war.  The  exchange  dealings  of 
Paris  or  Berlin  or  other  foreign  capitals  on  London,  or  on 
one  another,  differ  in  many  points  of  detail  from  the  opera- 
tions of  New  York  on  London.  Local  and  peculiar  banking 
customs  are  to  be  found  in  any  monetary  capital.1  How- 
ever, a  fairly  thorough  explanation  of  the  exchange  deal- 
ings of  some  one  country,  as  the  United  States,  will  disclose 
at  least  the  fundamental  principles  which  govern  in  opera- 
tions the  world  over.2 

i  The  Parisian  methods,  for  instance,  of  quoting  long  and  short 
exchange  on  other  centers  constitute  a  Chinese  puzzle  to  one  un- 
familiar with  the  system.  Compare  Clare's  "A  B  C  of  the  Foreign 
Exchanges,"  pp.  128  et  seq. 

2  It  is  not  designed  to  make  this  book  a  so-called  Arbitrage 
Manual.  Swoboda's  arbitrage  manual  attains  a  length  of  977  pages 
without  becoming,  or  attempting  to  become,  a  treatise  on  the  foreign 
exchanges  that  is  truly  useful  to  the  general  reader  or  ordinary 
banker  or  student.     [Note  continued  on  page  191.] 

190 


FOREIGN  MONEY  MARKET  FACTORS  191 

If  a  bank  is  to  carry  on  a  fully  rounded  out  and  inde- 
pendent business  in  exchange  on  any  given  foreign  country, 
as  say  England,  it  must  have  with  a  banking  establish- 
ment in  that  country  (1)  a  deposit  or  balance  and  (2)  an 

Note  on  the  Literature  of  Exchange.  The  arbitrage  manual  is  a 
practical  foreign  banking  hand-book  which  commonly  sets  forth  in 
much  detail  the  particular  banking  and  money  market  customs,  the 
methods  of  handling  and  pricing  bills  of  exchange,  the  laws  and 
customs  of  dealing  in  bonds  and  stocks,  the  methods  of  handling 
bullion,  the  stamp  taxes  levied  by  governments  upon  dealings  in 
bonds,  stocks  and  commercial  paper,  and  like  matters,  for  all  of  the 
countries  and  principal  money  capitals  of  the  world.  The  arbitrage 
manual  usually  assembles  its  subject  matter  country  by  country,  and 
city  by  city,  and  is  planned  so  as  to  give  much  of  the  data  required 
for  technical  arbitrage  operations  in  exchange.  The  following  are 
some  of  the  important  examples  of  these  books:  Otto  Swoboda, 
"Die  Arbitrage  (in  Wertpapieren,  Wechseln,  Miinzen,  und  Edel- 
metallon),"  (Thirteenth  Edition,  edited  by  Max  Fiirst),  Berlin,  1000; 
E.  KaufFmann,  "Banknotes,  Monnaies  et  Arbitrages,"  Paris,  1908; 
Ottomar  Haupt,  "Arbitrages  et  Parites"  (the  latest  edition  of  this 
book  in  the  possession  of  the  present  writer  is  the  eighth),  Paris, 
1894;  H.  T.  Easton,  "Tate's  Modern  Cambist,"  Twenty-fourth  edi- 
tion, London,  1908;  Henry  Deutsch,  "Arbitrage,"  London,  1904;  J.  H. 
Norman,  "Universal  Cambist,"  London,  1897.  (The  latter  work  is 
unlike  the  ordinary  arbitrage  manual,  being  occupied  almost  wholly 
with  the  author's  odd  and  elaborate  [and  not  over-useful]  monetary 
theory,  and  containing  relatively  little  information  on  the  practical 
arbitrage  and  exchange  customs  of  the  leading  monetary  countries.) 

The  following  books  on  Foreign  Exchange,  in  the  English  lan- 
guage, will  be  found  useful  reading  on  practical  exchange  dealings: 
Anthony  W.  Margraff,  "International  Exchange,"  Fourth  Edition, 
New  York  City,  1912;  Howard  K.  Brooks,  "Foreign  P^xchange  Text- 
book," Chicago,  1906;  Franklin  Escher,  "Elements  of  Foreign  Ex- 
change," Second  Edition,  New  York,  1911.  The  first  of  these  con- 
tains the  more  complete  treatment  of  the  subject.  The  third  is  a 
very  brief,  but  nevertheless  admirable  essay  on  the  exchanges  for 
the  American  student.  Two  very  good,  but  rather  short  books  on 
Foreign  Exchange  are  those  by  George  Clare,  "The  A  B  C  of  the 
Foreign  Exchanges,"  Fifth  Edition  reprinted,  London,  1911;  and 
"The  Money  Market  Primer  and  Key  to  the  Exchanges,"  Second 
Edition,  London,  1903.     Another  book  of  a  generally  similar  charac* 


L92  FOREIGN  EXCHANGE 

acceptance  account.  Circumscribed  and  somewhat  indirect 
operations  in  foreign  drafts  may,  however,  be  engaged  in  by 
a  smaller  bank  without  having  even  a  balance  abroad,  by 
aid  of  arrangements  which  it  can  make  with  some  larger 
home  institution  posessed  of  complete  foreign  facilities. 
A  greater  American  bank  not  infrequently  has  more  than 
one  balance  and  more  than  one  acceptance  account  in  Lon- 
don, but  for  present  purposes  it  will  suffice  to  speak  of  a 
single  balance  and  single  acceptance  account  and  of  the 
dealings  in  exchange  which  may  be  founded  upon  these  as 
a  basis.1  A  London  deposit  enables  a  bank,  without  the 
intermediation  of  any  other  home  institution,  to  sell  sterling 
sight  drafts  and  cables  and  to  issue  both  kinds  of  travelers' 
exchange  pa\*able  in  sterling,  and  also  to  buy  all  types  of 
sterling  exchange,  cables  and  sight  and  long  drafts,  and  as 
well  to  undertake  certain  minor  operations  which  need  not 
be  itemized.  We  have  already  paid  some  attention  to  the 
acceptance  account  (page  135).  To  have  such  an  account 
in  London  enables  a  bank  to  issue  commercial  letters  of 
credit  in  sterling  (involving  as  these  do  the  authorization 
of  long  drafts  upon  the  London  correspondent  for  its  ac- 

ter  is  Hartley  Withers'  "Money  Changing,"  London,  1913.  W.  F. 
Spaulding's  "'Foreign  Exchange  and  Foreign  Bills,"  London,  1915, 
may  also  be  mentioned.  "Foreign  Exchange,"  published  by  the 
Financier  Company,  New  York,  1902,  is  a  brief  treatise  on  the  sub- 
ject which  contains  certain  points  not  readily  available  elsewhere, 
but  which  is  so  unsystematic  as  not  to  be  suitable  for  the  ordinary 
reader.  "International  Trade  and  Exchange,"  X.  Y.,  1914,  by  H.  G. 
Brown,  a  book  of  the  more  scholarly  type,  is  devoted  in  part  to  the 
exchanges. 

"The  Theory  of  the  Foreign  Exchanges"  by  Viscount  George  J. 
Goschen,  was  an  early  and  important  essay  on  the  subject  which 
first  appeared  in  18G1  and  went  through  many  editions  and  was 
translated  into  the  principal  foreign  languages. 

3  The  writer  has  heard  of  an  instance  of  an  American  bank  having 
four  London  balances,  but  is  unable  to  say  whether  or  not  this  should 
be  regarded   as  entirely  exceptional. 


FOREIGN  MONEY  MARKET  FACTORS  193 

ceptance)  and  also  permits  it  when  it  desires  to  draw  and 
sell  its  own  long  sterling  bills. 

All  operations  in  exchange,  even  those  requiring  an  ac- 
ceptance account,  rest  ultimately  upon  the  foreign  balance, 
in  the  sense  that  the  latter  is  indispensable  for  carding 
them  through,  and  every  completed  operation  will,  whether 
earlier  or  later,  produce  either  a  debit  or  a  credit  to  this 
balance,  that  is  popularly  speaking  either  an  outpayment 
from  it  or  an  inpayment  into  it.  We  say  "completed" 
operation  because  one  might  speak  of  the  issue  of  a  letter 
of  credit  as  an  "operation"  and  this  mere  issue  of  itself 
will  not  affect  the  foreign  balance.  It  is  the  drawing  by 
the  beneficiary  under  the  credit  that  does  this,  and  con- 
ceivably he  might  not  draw  or  at  any  rate  he  might  not 
draw  for  the  full  amount  authorized.  If  we  think  of  his 
drawing  as  the  completion  of  the  operation  of  issue  of  a 
credit,  we  may  generalize  and  say  that  every  completed 
operation  in  exchange  alters  the  foreign  balance,  and  in  the 
following  manner:  (1)  sales  of  exchange  and  issues  of  com- 
mercial and  travelers'  credits  deplete  the  balance  and  (2) 
purchases  of  exchange  replenish  or  augment  it. 

The  time  intervening  between  an  exchange  transaction  at 
an  American  bank  and  the  final  effect  of  this  transaction  on 
the  bank's  London  balance,  may  be  anything  from  a  few 
moments  or  a  number  of  hours,  as  in  the  instance  of  the 
cable  transfer,  to  several  months,  as  in  certain  cases  in- 
volving long  bills.  For  this  reason  the  debits  and  credits 
to  this  balance  entered  on  any  given  day  will  be  found 
to  originate  in  a  great  number  of  operations  initiated  on 
many  different  dates  in  a  period  covering  several  months 
prior  to  that  given  day.  Thus  a  debit  entered  to-day  may 
have  followed  from  the  sale  of  a  cable  transfer  to-day  or 
yesterday,  or  from  the  sale  of  a  sight  draft  perhaps  six  or 
seven  days  ago,  or  even  from  the  issue  of  a  travelers'  or 
commercial  credit  a  number  of  months  back.     Or  a  credit 


194  FOREIGN   EXCHANGE 

of  to-day  may  have  resulted  from  the  purchase  of  a  cable 
within  a  few  hours  or  of  a  sight  draft  within  a  week.  Or 
it  mighl  be  the  consequence  of  a  sale  just  effected  in  the 
London  money  market  of  a  long  sterling  bill  bought  in  New 
York  about  a  week  ago  and  sent  over  for  immediate  dis- 
count and  cash  credit.  On  the  other  hand  it  may  come 
from  collection  at  maturity  on  a  90  days'  sight  bill  pur- 
chased in  America  about  one  hundred  days  since  and  held  as 
an  investment  for  the  interest  earnings  that  it  would  yield. 
A  foreign  balance  has  as  a  capital  a  high  rate  of  turn- 
over. That  is,  the  volume  of  business  sent  through  it  is 
very  large  in  proportion  to  the  balance  itself.  Any  lack  of 
equivalence  between  the  debit  and  credit  items  in  this  busi- 
ness will  therefore  tend  to  cause  large  fluctuations  in  the 
account.  In  view  of  the  fact  that  the  business  impinging 
upon  it  on  any  given  day  will  consist  of  a  large  and  mis- 
cellaneous group  of  exchange  operations  undertaken  in  the 
near  and  more  remote  past  by  the  bank  for  its  customers 
in  America,  determined  primarily  by  the  commercial  and 
other  requirements  of  these  customers,  it  is  manifest  it 
would  be  a  mere  accident  if  the  debits  and  credits  of  the 
given  day  should  offset  each  other.  Unless  corrected  by 
supplementary  or  stabilizing  operations,  this  business  might 
on  some  days  cause  the  balance  to  be  greatly  reduced  or 
to  disappear  and  on  others  to  rise  to  an  inordinate  sum. 
But  there  will  be  some  appropriate  figure  at  which  it  would 
best  stand,  depending  upon  the  quantity  and  character  of 
the  business  based  upon  it,  and  it  will  be  the  bank's  policy 
to  keep  it  as  close  to  this  figure  as  may  be  practicable.  Its 
normal  amount  should  not  be  allowed  to  fall  too  low  lest 
the  business  of  a  day  or  two  might  in  its  oscillations  produce 
a  heavily  overdrawn  condition.  Incidental  overdrafts  in 
the  kind  of  a  balance  which  we  are  now  discussing  are  in 
no  sense  crimes,  but  the  correspondent  charges  a  relatively 
high  rate  of  interest  upon  them  and  in  any  case  it  will  be 


FOREIGN  MONEY  MARKET  FACTORS     195 

the  bank's  program  to  keep  them  reduced  to  the  lowest 
terms.  It  is  sometimes  provided  in  the  agreement  with  the 
correspondent  that  a  certain  average  daily  balance  shall 
be  maintained  as  a  minimum.  On  the  other  hand,  a  need- 
less surplus  in  this  deposit  above  the  appropriate  working 
figure  is  undesirable  because  it  means  the  depletion  of 
funds  available  for  employment  in  regular  banking  at 
home.4  Suppose,  for  illustration,  the  existence  of  such  an 
overplus  amounting  to  £10,000.  This  will  have  been  caused 
by  excess  purchases  of  exchange  of  a  present  value  on 
arrival  of  £10,000,  and  this  exchange  will  have  cost  in  ordi- 
nary times  something  more  than  $48,000  of  local  money  of 
the  United  States.  This  sum  of  dollars  will  have  disap- 
peared from  the  resources  of  the  bank  at  home  and  will 
have  reappeared  as  sterling  in  the  deposit  in  London.  Its 
disappearance  at  home  is  not  the  less  complete  for  the  time 
being  because  of  its  reappearance  in  converted  form  abroad. 
Though  the  fund  is  not  lost  to  the  bank,  it  is  in  the  wrong 
place  and  form.  To  bring  it  back  home  it  will  simply  be 
necessary  to  sell  £10,000  of  sterling  exchange  (sight  drafts 
or  cables)  in  the  home  market.  This  sale  will  restore  some- 
thing over  $48,000  to  the  home  resources,  depending  upon 
the  rate  of  exchange.  Very  likely  the  exchange  will  be 
bought  by  some  other  bank  or  banks  whose  own  particular 
circumstances  make  them  have  a  need  for  it. 

In  practice  the  surplus  of  £10,000  in  the  London  deposit 
would  not  be  allowed  to  build  up,  but  would  rather  (if  it 
tended  to  accumulate)  be  torn  down  progressively  by  sales 
of  exchange  on  the  market  as  they  might  be  required  for 
this  purpose.     When  its  primary  business  in  exchange  hap- 

*  Certain  conditions  may  make  it  advisable  to  place  fairly  large 
funds  in  loans  or  discounts  in  the  foreign  country,  and  this  through 
the  agency  of  the  correspondent  bank,  but  such  funds  would  not  in 
any  event  remain  in,  or  be  carried  in,  the  balance  with  the  corre- 
spondent . 


L96  FOKKKiN   EXCHANGE 

pens  to  run  in  channels  tending  to  produce  a  deficiency  in 
the  foreign  balance,  the  bank  will,  of  course,  to  provide 
againsl  this,  find  it  necessary  to  buy  exchange  in  the  market 
to  be  remitted  to  the  correspondent. 

To  maintain  a  policy  of  stabilizing  its  foreign  balance, 
the  bank  must  evidently  keep  as  close  track  as  possible  of 
the  daily  fluctuations  in  this  account.  Suppose  the  natural 
flow  of  its  business  in  exchange  with  its  customers,  is  pre- 
destined  to  produce  a  heavy  net  debit  to  the  balance  on  say 
July  10th,  and  assume  that  the  bank  is  one  week  removed 
in  mail  time  from  its  correspondent,  then  perfect  correction 
for  this  fluctuation  through  a  remittance  of  specially  pur- 
chased sight  bills  would  require  foreknowledge  on  July  3d 
and  the  buying  in  of  the  bills  on  that  day.  A  purchase  of 
cables  on  a  much  later  date  could  of  course  be  made  to  serve, 
and  doubtless  much  of  the  demand  in  the  open  market  for 
cables  is  to  be  accounted  for  by  their  emergency  utility  in 
providing  cover  in  such  cases  as  this.  Clearly  the  bank 
needs  foreknowledge  of  the  events  to  transpire  in  its  for- 
eign balance,  but  what  has  already  been  said  indicates  that 
this  foreknowledge  cannot  in  fact  be  quite  perfect.  As 
for  the  credits  that  are  about  to  come  into  being,  practically 
all,  or  the  vast  majority  of  these,  spring  from  the  bank's 
own  remittances  of  exchange,  and  with  the  exception  of 
one  class  the  credits  are  pretty  closely  under  its  control 
and  foreknowledge.  The  only  uncertainty  respecting  the 
precise  time  of  the  becoming  effective  of  these  credits  is 
that  attaching  to  the  transmission  of  mail  and  telegrams, 
and  this  uncertainty  is  not  great  in  times  of  peace.  The 
exceptional  class  of  credits  are  those  arising  from  the  remit- 
tance of  documentary  payment  trade  bills.  As  we  have 
seen  (in  §  35)  these  instruments  are  paid  off  at  any  time 
between  acceptance  and  maturity  according  to  the  pleasure 
of  the  drawee.  Under  the  banking  customs  of  England 
they  cannot  be  discounted  on  arrival  as  can  other  long  bills, 


FOREIGN  MONEY  MARKET  FACTORS  197 

and  therefore  in  general  the  precise  time  when  they  will 
produce  their  credits  cannot  be  foretold.  On  the  other 
hand,  a  schedule,  based  on  experience,  of  the  probable  yield 
day  by  day  from  a  known  lot  of  these  bills  can  be  and  is 
worked  out  in  practice  by  the  banker. 

With  respect  to  debits,  the  time  when  many  of  these  will 
become  operative  is  less  under  the  bank's  foreknowledge  and 
control.  The  dates  on  which  drafts  will  be  drawn  under 
travelers'  and  commercial  credits,  and  consequently  the 
dates  when  these  bills  will  finally  work  reductions  in  the 
balance,  are  not  determined  by  the  bank  but  depend,  within 
the  limits  set  by  the  duration  of  the  credits,  upon  the  con- 
venience of  the  beneficiaries.  In  the  case,  however,  of  long 
bills  under  commercial  credits,  the  bank  gains  foreknowl- 
edge of  the  dates  of  ultimate  charge  to  the  balance,  a  con- 
siderable period  prior  to  the  event,  from  the  advices  for- 
warded by  the  correspondent  telling  the  dates  of  acceptance 
of  these  bills  as  they  have  been  presented.  A  ninety  days' 
sight  bill  accepted  on  July  1st  will  become  payable,  93  days 
thereafter,  on  October  2d,  and  the  American  bank  which 
has  granted  the  credit  may  well  learn  of  this  date  as  early 
as  July  the  7th  or  shortly  thereafter.  Sight  drafts  drawn 
by  the  bank  itself  and  sold  to  its  customers  or  the  general 
public  may  be  out  a  longer  or  a  shorter  time  before  present- 
ment for  payment  at  the  counters  of  the  correspondent,  de- 
pending upon  the  promptness  and  number  of  transfers 
made  by  the  persons  handling  them,  and  therefore  even  in 
their  case  the  time  of  debiting  the  balance  is  not  foreknown 
with  absolute  precision. 

An  ordinary  depositor  with  a  bank  commonly  judges  of 
the  state  of  his  deposit  by  his  check  stubs,  though  he  real- 
izes the  record  on  these  stubs  is  in  error  at  any  time  when 
there  are  outstanding  checks.  But  for  an  exchange  bank 
it  would  be  out  of  the  question  to  take  the  mere  record  of 
the  dates  and  amounts  of  its  own  remittances  and  drawings 


L98  FOREIGN  EXCHANGE 

of  exchange  and  issue  of  credits,  as  sufficient  evidence  of 
the  condition  of  its  foreign  deposit.  So  it  prepares  from 
advices  received  and  from  oilier  data  interpreted  in  the 
light  of  experience,  a  corrected  memorandum  account  de- 
signed to  show  from  day  to  day  in  the  near  future  the 
approximately  em-feel  stale  of  its  balance  as  it  will  appear 
in  fact  according:  to  the  books  of  the  correspondent.  To 
be  on  the  safe  side  in  making  up  this  memorandum,  it 
should  assume  maximum  periods  to  transpire  before  credit 
items  started  on  their  way  become  effective,  and  make 
allowance  for  the  expiry  of  minimum  periods  only  before 
debits  known  to  be  in  process  will  be  charged.  It  will  be 
on  the  basis  of  this  memorandum  that  the  bank  will  make 
its  compensatory  purchases  or  sales  of  exchange  on  the 
open  market  to  stabilize  its  balance.5 

To  summarize  we  may  formulate  what  might  perhaps  be 
called  the  rule  of  equal  sales  and  purchases.  This  runs 
to  the  effect  that — setting  aside  circumstances  when  it  is 
desirable  to  change  the  foreign  balance  itself  or  alter  the 
foreign  loan  funds  if  there  are  any — the  bank  must  keep 
its  current  purchases  and  sales  of  exchange  at  a  substantial 
equality.  In  interpreting  this,  the  issue  of  travelers'  and 
commercial  credits  are,  to  the  extent  to  which  these  credits 
are  utilized,  to  be  treated  as  sales,  or  as  being  like  sales  of 
exchange.  And  it  is  to  be  kept  in  mind  that  sales  of  long 
bills  on  a  given  date  may  be  offset  by  purchases  of  sight 
drafts  or  cables  at  much  later  dates  (depending  on  the 
length  of  life  of  the  long  bills),  and  similarly  the  purchase 
of  a  long  bill  to  be  held  as  an  investment  will  be  offset  by 
a  subsequent  and  not  by  a  contemporaneous  sale  of  sight 
bills  or  cables. 

Under   given   conditions   of   commerce    and   travel,   the 

e  When  the  matter  is  regarded  as  of  sufficient  importance  the  bank 
may  obtain  from  its  correspondent  a  telegraphic  report  as  to  the 
amount  of  its  balance  at  the  close  of  any  given  day.     A  very  large 


FOREIGN  MONEY  MARKET  FACTORS  199 

clients  of  an  individual  bank  will  have  certain  exchange 
requirements  which  this  institution  will  undertake  to  meet. 
If  these  requirements  are  such  as  to  produce  an  excess  of 
debits  to  its  foreign  balance,  it  will  be  forced  into  the  open 
market  as  a  purchaser  of  exchange.  But  another  bank 
ma}*  be  driven  into  this  market  on  the  same  day  as  a  seller 
of  exchange,  by  reason  of  reverse  conditions  which  happen 
to  affect  it  through  its  customers.  And  so  some  banks  buy 
and  some  sell.  If  in  the  whole  country  there  is  an  excess 
of  supply  of  exchange  or  an  excess  of  demand  produced  in 
this  way,  and  this  excess  persists,  a  gold  import  or  export 
will  result.6  The  problem  of  tracing  out  the  detail  of  this 
process  belongs,  however,  to  a  later  chapter. 

We  have  pictured  the  open  market  business  in  exchange, 
namely  that  taking  place  among  banks  and  dealers  inter  se, 
as  being  determined  by  the  commercial  and  other  needs  of 
the  general  mercantile  and  traveling  public  (and  of  the 
immigrants)  as  these  needs  make  themselves  felt  through 
demands  made  on  the  individual  banks.  This  picture  is 
essentially  correct,  but  it  should  be  stated  that  exchange 
investment,  borrowing,  speculation  and  arbitrage  also  are 
responsible  for  a  considerable  portion  of  the  open  mar- 
ket dealings.  Even  these  sources  of  operation  are  commer- 
cially determined  in  a  fundamental,  though  more  round- 
about way.  We  here  think  of  "commerce"  as  including 
international  traffic  in  bonds  and  stocks  as  well  as  in  com- 
modities. 

§  53.  The  services  and  compensation  of  correspondent 
banks. — One  bank  is  said  to  be  a  correspondent  of  another 
if  it  is  under  a  standing  agreement  to  make  disbursements 

bank  mi;/ht  desire  to  receive  such  reports  regularly,  expense  per- 
haps being  an  insufficient  objection. 

8  Assuming  the  gold  standard  in  both  countries  concerned  and 
assuming  a  free  traffic  in  gold,  practically  speaking,  assuming  con- 
ditions of  peace. 


200  FOREIGN  EXCHANGE 

or  take  in  receipts  for  the  account  of  this  other:  or,  a 
eorrespondenl  is  a  bank  that  acts  as  agent  of  another  bank- 
ing house  under  a  regular  and  continuing  arrangement. 
Assuming  this  definition,  it  is  not  essential  that  the  one 
called  the  correspondent  should  hold  a  deposit  from  the 
other.  The  present  section,  however,  will  discuss  only  that 
more  important  type  of  correspondent  which  does  hold  a 
deposit,  and  will  be  content  to  cover  the  subject  by  exam- 
ining, as  a  leading  example,  the  activities  of  a  London 
bank  in  its  service  as  correspondent  for  one  in  America. 
Its  operations  in  behalf  of  the  latter  may  be  divided  into 
two  main  classes:  (1)  those  which  result  in  a  disburse- 
ment from  or  debit  to  this  bank's  balance,  and  (2)  those 
which  involve  an  inpayment  or  credit  to  it.  There  follows 
a  fairly  detailed  list  of  these  operations. 

I.  OPERATIONS  INVOLVING  A  DEBIT  TO  THE 
BALANCE 

1.  The  London  bank  cashes  cable  transfers  and  sight  drafts,  or 

checks,  drawn  upon  it  directly  by  the  American  bank  itself. 
It  pays  out  money  or  money  funds  against  these  to  the  par- 
ties designated,  and  forthwith  deducts  the  amounts  thus 
disbursed  from  the  drawing  bank's  balance. 

2.  It  cashes  sight  drafts  drawn  upon  it  by  travelers  under  circular 

letters  of  credit  issued  by  the  American  bank,  and  also  cashes 
"travelers'  cheques"  issued  by  the  latter  if  there  are  any. 

3.  It  cashes  checks  drawn  upon  it  by  various  smaller  American 

banks  which  have  no  deposit  with  it  (or  any  other  institution 
in  London)  but  which  have  procured  authority  from  the 
American  bank  that  has  the  balance,  to  draw  against  this 
balance  or  for  payment  out  of  it.     (Compare  §  77  to  follow.) 

4.  It  makes  various  remittances  by  cable  or  mail  on  the  order  of 

the  American  bank  to  designated  parties. 

5.  It  accepts,  and  subsequently  pays,  the  long  bills  drawn  upon  it 

by  shippers  under  the  authority  of  commercial  letters  of 
credit  issued  by  the  American  bank  (compare  Chapter  VII). 


FOREIGN  MONEY  MARKET  FACTORS  201 

The  latter's  balance  is  debited  at  the  time  of  the  payment  of 
these  bills.  In  case  a  commercial  letter  of  credit  should  au- 
thorize a  sight  draft,  the  London  bank  would,  of  course,  pay 
upon  presentation  without  a  separate  acceptance. 

6.  It  accepts  and  at  maturity  pays  any  long  bills  drawn  upon  it 

by  the  American  bank  itself. 

7.  If  the  American  bank  is  one  of  the  relatively  few  larger  insti- 

tutions that  make  gold  shipments,  the  correspondent  may 
buy  gold  upon  its  order  in  London,  pack  and  forward  it,  and 
charge  its  account  for  the  cost  of  purchase  and  the  incidental 
expenses  and  freight  or  express  (all,  of  course,  in  sterling). 
To  enable  this  operation  to  be  carried  through  on  anything 
like  the  usual  scale,  the  American  bank's  London  account 
would  have  to  be  fortified  by  special  remittances  of  sterling 
exchange  procured  in  the  American  market  for  the  express 
purpose  of  engineering  a  gold  import.  (Compare  Chapter 
XX  to  follow).  Indeed  the  quantity  of  gold  moved  in  a 
single  shipment  may  easily  have  a  value  of  ten  or  twenty 
times  the  amount  in  the  bank's  London  balance. 

8.  The  London  bank  will  honor  overdrafts  if  covered  by  collateral 

security — at  least  it  is  safe  to  say  that  the  usual  and  standard 
arrangement  demands  that  collateral  protect  all  overdrafts. 
Overdrafts  that  arise  as  mere  incidents  to  the  business  in 
exchange  are  in  no  sense  reprehensible,  though  a  chronic 
state  of  being  overdrawn  would  be  out  of  the  question.  The 
American  bank  pays  interest  on  the  amount  overdrawn  for 
the  time  it  is  overdrawn. 

II.  OPERATIONS  INVOLVING  A  CREDIT  TO  THE 
BALANCE 

1.  The  London  bank  credits  the  balance  of  the  American  insti- 

tution with  any  remittances  made  by  it  by  way  of  cable 
transfer. 

2.  It  gives  credit  for  sight  drafts  on  London  bankers  sent  over 

for  deposit  with  it. 

3.  It  also  collects  and  credits  checks  drawn  on  other  cities. 

4.  It  handles  long  sterling  bills  purchased  in  America  and  sent 

over  to  it.     These  will  be  bills   (a)   of  bankers  on  bankers,., 


202  FOREIGN   EXCHANGE 

or  (b)  of  merchants  on  bankers  under  letters  of  credit,  or 
(e)  of  merchants  on  merchants.  The  London  correspondent 
procures  the  acceptance  of  these  hills  by  the  drawees,  man- 
ages  the  documents  (when  present)  according  to  instructions, 
and  credits  the  remitting  bank's  balance  with  any  cash  pro- 
ceeds  from  the  instruments  at  the  actual  time  of  the  receipt 
of  these  proceeds  whether  from  discount  or  from  payment 
at  maturity  or  prepayment  by  the  drawee. 
5.  If  the  American  hank  makes  a  gold  export  from  the  United 
States  to  England,  its  London  correspondent  will  probably 
be  the  agent  to  take  charge  of  the  gold  on  arrival,  and  will 
credit  the  formers  balance  with  the  sterling  proceeds  of  the 
sale  of  this  specie.  This  extraordinary  credit  will  be  coun- 
terbalanced by  large  and  special  sales  of  sterling  drafts  by 
the  exporting  bank  on  the  American  side  of  the  water. 
(Compare  No.  7  above.) 

If  a  bank  located  outside  of  England  has  a  branch  in 
London,  the  latter  would  naturally  take  on  many  of  or  all 
the  functions  otherwise  exercised  by  a  correspondent,  ex- 
cept that  it  could  not  so  well  act  as  an  acceptor  of  long  bills 
drawn  by  the  parent  institution.  It  should  be  said  a  cor- 
respondent bank  will,  in  addition  to  the  acts  mentioned 
above,  also  buy  or  sell  investment  securities  in  the  London 
market  for  the  account  of  the  foreign  bank  having  relations 
with  it. 

The  compensation  of  the  correspondent  hank. — Petty  ex- 
penses (such  as  postal  and  cable  charges  and  stamp  taxes) 
incurred  by  the  correspondent  as  agent  of  the  American 
bank,  are  deducted  from  the  latter 's  account.  But  the  mere 
collection  of  these  charges  does  not  afford  the  correspondent 
a  compensation  for  its  services.  This  compensation  is,  how- 
ever, always  provided  for.  It  usually  assumes  the  form 
of  (1)  interest  earnings  and  (2)  commissions.  The  in- 
terest element  in  this  compensation  consists  in  very  small 
part,  or  perhaps  in  no  part,  of  rates  of  interest  paid  directly 
as  such  by  the  American  bank  to  the  correspondent,  for 


FOREIGN  MONEY  MARKET  FACTORS  203 

such  payments  will  be  made  only  in  case  this  bank  over- 
draws its  account  or  secures  a  straight  or  direct  loan  from 
the  correspondent.7  And  in  any  event,  such  payments  are 
more  in  the  nature  of  special  remuneration  for  the  London 
bank's  loans  than  in  the  nature  of  general  compensation 
for  its  ordinary  services  as  a  correspondent.  The  interest 
element  in  this  general  compensation  consists  in  the  interest 
earnings  gained  by  the  correspondent  from  such  use  in  its 
banking  business  as  it  is  able  to  make  of  the  American  in- 
stitution's funds  carried  on  deposit  with  it.  This  type  of 
compensation  is  the  same  as  that  secured  by  any  common 
commercial  bank  from  the  employment  of  the  deposits  of 
its  ordinary  mercantile  and  other  customers. 

It  should  be  noted  incidentally  that,  as  custodian  of  the 
American  bank's  foreign  balance,  the  London  correspondent 
will  have  the  first  chance  to  discount  (or  buy)  at  market 
rates  a  large  and  regular  inflow  of  good  grade  long  sterling 
bills  which  have  been  bought  by  the  American  company 
and  forwarded  in  the  course  of  its  regular  business  in  ex- 
change. If  it  does  not  care  to  buy  these  bills  itself,  it  may 
sell  them  on  the  open  London  market.  In  any  case  the 
option  which  it  has  in  this  connection  is  doubtless  worth 
something  to  it.  That  is,  the  business  brought  to  it  in 
this  manner  probably  gives  increased  opportunity  for  the 
remunerative  and  safe  employment  of  its  banking  funds. 
This  is  similar  to  the  fact  that  valuable  business  is  brought 
to  the  ordinary  commercial  bank  by  its  depositors. 

It  is  not  the  general  custom  of  American  commercial 
banks  to  pay  interest  on  ordinary  deposits,  and  so  the  in- 
terest earnings  gained  by  the  banks  from  these  funds  are 
retained  wholly  in  their  hands.  It  is  likewise  not  custom- 
ary for  the  greater  London  commercial  banks  to  pay  in- 
terest on  the  checking  accounts    (or  demand   deposits)   of 

7  The  reader  will  readily  distinguish  between  a  direct  loan  and 
the  acceptance  of  long  bills  for  the  American  bank. 


204  FOREIGN  EXCHANGE 

merchants  and  common  clients,  but  they  do  make  arrange- 
ments In  pay  interest  upon  the  working  balances  (namely 
checking  accounts)  of  banks  which  make  use  of  them  as 
correspondents.  With  this  may  be  compared  the  practice 
of  New  York  banks  of  paying  interest  on  the  balances  which 
interior  hankers  carry  with  them  and  use  as  the  basis  of 
a  business  in  New  York  exchange.  A  rate  of  interest 
paid  by  a  London  bank  or  discount  house  upon  deposits 
is,  in  England,  called  a  deposit  allowance  rate. 

Between  London  and  American  (and  presumably  other 
foreign)  banking  establishments  there  are  in  operation  two 
plans  of  disposing  of  the  question  of  interest  on  balances. 
These  are  (1)  an  agreement  that  the  depositing  bank  shall 
receive  the  deposit  allowance  rate  on  its  entire  daily  bal- 
ance, or  (2)  an  alternative  agreement  that  this  institution 
shall  maintain  with  the  correspondent  a  stipulated  mini- 
mum average  daily  balance,  as  perhaps  £5,000  or  £10,000, 
upon  which  no  interest  is  to  be  received.  The  latter  is 
called  an  "interest-free  balance."  Even  under  the  first 
of  these  agreements  the  London  bank  doubtless  enjoys 
some  gain  from  the  use  of  the  deposited  funds,  since  their 
interest  earnings  will  almost  always  exceed  the  deposit 
allowance  rate.  But  under  the  plan  of  the  interest-free 
balance,  the  earnings  of  this  fund  are  reserved  in  their 
entirety  by  the  correspondent  for  itself.  This  is  less  lib- 
eral to  the  American  banker,  but  by  way  of  offset  there 
will  be  coupled  with  this  arrangement  a  lower  or  more 
favorable  schedule  of  commissions  to  be  paid  by  the 
latter. 

The  undertaking  to  keep  on  hand  a  certain  average  daily 
interest-free  balance,  is  not  an  engagement  that  the  deposit 
shall  never  fall  below  the  stipulated  figure.  The  balance 
for  any  given  day  is  counted  as  it  stands  at  the  close  of 
business  on  that  day.  If  it  falls  below  the  agreed  amount 
on  one  day,  this  may  be  made  up  by  its  being  sufficiently 


FOREIGN  MONEY  MARKET  FACTORS  205 

in  excess  on  another.  A  bank  operating  in  exchange  can 
hardly  control  the  exact  figure  at  which  its  deposit  shall 
stand  at  the  close  of  business  on  any  one  day,  but  it  is 
entirely  feasible  for  it  to  control  the  average  for  a  quarter 
or  half  year.  If  now  the  average  is  in  fact  maintained 
at  a  higher  level  than  the  required  minimum,  the  deposit 
allowance  rate  would  be  due  on  the  excess  for  the  time 
during  which  it  is  present.  Every  quarter,  or  perhaps 
every  half  year,  any  interest  which  has  thus  become  due 
will  be  credited. 

Interviews  with  a  number  of  American  bankers  indicate 
that  arrangements  between  our  banks  and  their  London 
correspondents  pertaining  to  the  character  and  amount  of 
the  compensation  of  the  latter,  vary  in  detail  to  no  incon- 
siderable extent.  The  London  banks  make  no  general  and 
open  offers  of  terms  under  which  they  are  ready  to  conduct 
foreign  accounts.  Each  arrangement  is  a  case  by  itself, 
and  an  American  banker  regards  the  terms  of  his  London 
account  as  strictly  private.  Greater  banks  and  banks  with 
higher  standing  receive  preferential  treatment.  It  may  be 
said  with  respect  to  commissions,  there  appear  to  be  two 
leading  classes  of  agreements  known  to  practice.  Under 
one  there  is  put  in  force  a  schedule  of  separate  commis- 
sions for  various  and  distinct  acts  or  operations  performed 
by  the  correspondent.  The  chief  commission-bearing  acts 
may  be  listed  as  follows : 

The  acceptance  of  long  bills  drawn  under  commercial  letters  of 

credit. 
The  acceptance  of  long  bills  drawn  by  the  American  bank  itself. 
The  handling  of  trade  bills  including  the  care  of  the  documents 

and  the  procuring  of  the  drawee's  acceptance. 
The  encashment  of  traveler's  drafts  under  circular  letters  of 

credit. 

Another  class  of  agreement  provides  for  the  payment  of  a 


206  FOREIGN  EXCHANGE 

tint  rate  of  commission  on  all  items  going  through  the  bal- 
ance one  way,  as  for  instance  on  all  items  credited.  This 
may  he  called  a  commission  on  the  turnover.  Under  this 
scheme  there  will  he  presumably  no  special  commissions  for 
distinct  services  except  for  acceptances.  The  commission 
on  the  turnover  may  range  from  V±  of  1%  at  the  highest 
to  say  J4o  of  1%  at  the  lowest. 

A  new  and  distinctive  plan  of  compensation  for  the  cor- 
respondent has  been  brought  forward  in  recent  times,  and 
is  said  to  be  in  operation  in  some  cases.  Under  this  plan 
the  depositing  bank  pays  the  correspondent  simply  an 
agreed  lump  sum  periodically,  as  perhaps  £200  a  year,  and 
goes  free  of  detailed  commission  charges  and  receives  in- 
terest on  its  entire  balance.  In  proposing  this  scheme,  the 
London  banker  say,  as  it  were,  ''pay  us  a  salary."  This 
plan  has  the  advantages  of  simplicity,  reduction  of  clerical 
labor,  and  freedom  from  small  taxation  upon  individual 
operations  in  exchange.  The  fixed  periodical  compensation 
would  depend  on  the  business  going  through  the  balance 
on  the  average,  and  would,  of  course,  be  open  to  revision 
from  time  to  time. 

The  standard  deposit  allowance  rate  on  bankers'  balances 
carried  in  London  with  the  great  joint  stock  banks  appears 
to  be  1%  under  the  Bank  of  England  rate.8  When  the 
Bank  of  England  rate  is  3%  it  will  be  2%,  and  when  the 
Bank  rate  is  4%  it  will  be  3%,  and  so  on.  There  will,  how- 
ever, usually  be  a  maximum  figure  set  for  the  deposit  allow- 
ance rate,  as  say  4%,  so  that  when  the  Bank  of  England 
rate  under  unusual  conditions  ascends  to  six  or  seven  per 
cent,  or  even  higher,  the  deposit  allowance  rate  will  not 
follow  on  up  above  4%. 

The  schedule  of  commissions  is  likely  to  involve  something 
on  the  order  of  the  following  figures: 

»S'ee  §  58  below. 


FOREIGN  MONEY  MARKET  FACTORS  207 

Acceptance  of  bills  drawn  under  commercial  letters  of  credit, 

Mg  of  1%  per  month  of  life  of  the  bill. 
Acceptance  of  the  American  bank's  own  long  bills.     The  same, 

or  a  somewhat  lower  commission. 
Cashing  of  drafts  drawn  under  travelers'  letters  of  credit,  Vio 

of  1%. 
Confirmation  of  commercial  letter  of  credit,  Vio  to  Vs  of  1%  in 

general  without  regard  to  length  of  life. 
Handling  bills  with  documents  attached,  V\q  of  1%. 

It  is  understood  these  are  commissions  assessed  by  the 
London  correspondent  against  the  American  bank.  The 
latter  will  in  turn  make  its  own  commission  charges  to  such 
of  its  customers  as  are  accommodated  by  the  issue  of  letters 
of  credit  or  by  the  collection  of  drafts.  The  reason  why 
acceptance  commissions  are  roughly  proportional  to  the 
length  of  life  of  the  drafts  accepted,  was  discussed  in 
§50. 

§  54.  The  dealers  in  money  in  the  London  market :  the 
joint  stock  banks. — The  principal  lenders  of  money  in  Lon- 
don may  be  grouped  in  four  classes  which  are  peculiar  to 
that  city.  These  are,  in  the  order  in  which  they  will  be 
considered:  (1)  the  joint  stock  banks,  (2)  the  bill  brokers 
and  discount  houses,  (3)  the  London  branch  establishments 
of  colonial  and  foreign  banks,  and  (4)  the  Bank  of  Eng- 
land, which  may  be  regarded  as  constituting  a  class  in  it- 
self. In  addition  to  these  there  are  the  private  banking 
houses  and  the  so-called  "acceptance  houses,"  which  if  not 
generally  lenders  of  money  are  at  least  factors  in  the  Lon- 
don money  market  in  other  ways.0 

'•>  The  following  references  on  the  London  money  market  may  be 
mentioned:  Hartley  Withers,  "The  Meaning  of  Money,"  second  edi- 
tion, London,  1909,  and  "Stocks  and  Shares,"  New  York,  1910,  and 
"The  English  Banking  System,"  Publications  of  the  U.  S.  Monetary 
Commission,  vol.  8,  1910,  and  "War  and  Lombard  Street,"  London, 
1915;  F.  Straker,  "The  Money  Market,"  London,  1904;  George  Clare, 
"Money  Market   Primer"   etc.,  London,    1903;   II.  T.   Easton,    ''Banks 


208  FOREIGN  EXCHANGE 

A  few  words  in  passing  on  the  acceptance  houses:  this 
term  is  in  London  applied  to  a  class  of  firms  which  were 
formerly  regular  mercantile  establishments,  but  which  have 
since  developed  a  business  of  granting  their  acceptances 
for  a  commission,  without  their  becoming  banks  in  the  full 
sense  of  the  word.  They  began  merely  by  accepting  long 
bills  of  exchange  drawn  upon  themselves  against  goods 
purchased  abroad  by  themselves,  but  came  in  the  course 
of  time  to  act  as  acceptors  (and  necessarily  as  drawees)  of 
bills  drawn  against  imports  made  by  other  English  mer- 
chants of  less  consequence  or  inferior  standing.  One  can 
see  how  a  business  of  this  character  might  arise.  Suppose 
a  relatively  obscure  merchant  wished  to  import  something 
from  a  distant  country,  but  could  not  induce  the  exporter 
to  ship  it  against  a  draft  to  be  drawn  merely  upon  him  in 
person.  Conceivably  he  might  go  to  a  large  and  well  known 
house  at  home  and  ask  it  to  make  the  import  for  him  on 
commission.  In  such  a  case  the  exporter  would  draw  upon 
this  well  known  house.  But  another  plan  is  possible,  and 
this  other  plan  long  ago  came  into  fashion  in  London. 
The  greater  mercantile  house  tells  the  lesser  merchant,  in 
effect,  to  make  the  import  himself  but  to  instruct  the  ex- 
porter to  draw  on  it,  and  it  undertakes  to  accept,  and  there- 
fore of  course  to  pay,  the  draft,  and  to  inform  the  ex- 
porter that  it  will  do  so.  For  this  service  the  greater  house 
charges  an  acceptance  commission.  It  will  require  the 
small  merchant  to  put  it  in  funds  in  time  to  pay  the  draft 
at  its  maturity.  This  time  will  be  deferred  long  enough  to 
permit  the  arrival  and  sale  of  the  goods  meanwhile,  this 

and  Banking,"  London,  1904;  Charles  Duguid,  "How  to  Read  the 
Money  Article."  All  these  are  descriptive  specifically  of  London. 
"Interviews  on  Banking  and  Currency  Systems,"  Publications  of  the 
U.  S.  Monetary  Commission  (Senate  Document  405,  61st  Cong.,  2d 
session )  contain  much  of  interest  concerning  the  money  market  in 
England  and  in  other  countries  also. 


FOREIGN  MONEY  MARKET  FACTORS  209 

result  being  accomplished  by  having  the  draft  of  the  ex- 
porter drawn  at  a  sufficiently  lengthy  term  or  usance  to 
make  it  possible.  Evidently  we  have  here  practically  the 
same  piece  of  business  as  that  done  by  a  bank  proper  when 
it  issues  a  commercial  letter  of  credit  authorizing  a  draft 
or  drafts  on  itself,  as  already  described  in  §  37.  The  Lon- 
don acceptance  houses,  originally  mercantile  establish- 
ments, have  in  general  abandoned  actual  trade  and  have 
specialized  in  acceptances  and  in  certain  lines  of  finance. 
They  once  had  possession  of  the  acceptance  business,  and 
the  more  recent  entry  of  the  regular  banks  into  this  field 
has  been  something  of  a  blow  to  them.  In  later  days  they 
have  come  to  act  as  financial  agents  of  foreign  governments 
and  corporations  aiding  them  in  the  sale  of  securities  in 
London.  The  acceptance  house  is  technically  distinguish- 
able from  a  bank  in  that  it  pays  claims  against  itself,  not 
in  cash  over  the  counter,  but  by  a  check  drawn  on  a  bank 
proper.  The  directors  of  the  Bank  of  England  are  selected 
in  great  part  from  among  the  members  of  the  accepting 
firms. 

The  London  "joint  stock  banks"  are  given  this  name 
because  they  are  incorporated,  but  they  are  put  in  a  separate 
class  not  for  this  reason,  but  because  the  business  which 
they  transact  is  of  a  distinct  character.  The  classification 
is  a  matter  of  the  function  of  these  establishments  and 
not  of  their  form.  At  present  writing  (1919),  there  are 
three  discount  houses  which  are  joint  stock  companies  as 
well  as  the  great  banks.  The  business  of  the  London  joint 
stock  banks  is  generally,  though  not  wholly,  similar  to  that 
of  the  regular  commercial  banks  of  America.  On  the  fol- 
lowing page  is  given  a  balance  sheet  of  the  London  County 
and  Westminster  Bank,  Ltd.,  for  June  30,  1913.  This 
shows  the  condition  of  one  of  the  largest  of  the  London 
banks  on  a  date  not  long  before  the  outbreak  of  the 
war. 


210                         FOREIGN  EXCHANGE 
LONDON  COUNTY  AND  WESTMINSTER  BANK,  LD.10 
Balance  Sheet — June  30,  1913 

Liabilities  Assets 

£  Cash                                                     £ 

(1)  Capital— 700,000    shares    of  (9)  —In   hand   and   at  Bank 

Bach,   £6  paid 3,500,000  of  England    9,628,249 

(2)  Reserve     4,000,000  (10)  — At   call    and   short   no- 

(;!>  Current    and     deposit     ac-  tice     11,147,811 

counts      81,442,141  (11)  Bills    discounted    18,340,178 

(  li  Circular    notes,    letters    of  (12)  Investments*    9,152,174 

credit,      etc.,      etc.,      in-  (13)  Advances    to       customers 

eluding     provisions     for  and    other    accounts.  .43,304,996 

contingencies     3,952,041  (14)  Liability      of      customers 

(5)  Acceptances        for        cus-  for  acceptances,  as  per 

tomers    7,158,931  contra     7,158,931 

(6)  Endorsements       on       bills  (15)  Bills    negotiated     as    per 

negotiated      627,070  contra     627,070 

(7 1  Rebate  on  bills  not  due..        94,741  (16)  Bank    and    other    prem- 

(8)  Profit  and   loss    account..      304,110  ises     1,719,625 


101,079,034  101,079,034 

As  a  means  of  explaining  the  nature  of  the  business 
of  a  typical  joint  stock  bank,  we  may  consider  the  items 
in  this  balance  sheet  seriatim.  It  will  be  necessary  to 
assume  the  reader  possesses  a  general  familiarity  with  the 
meaning  of  bank  statements. 

Items  on  the  Liabilities  Side 

(1)  Capital— 700,000  shares  of  £20  each,  £5  paid.  This 
is  the  same  item  as  "capital"  or  "capital  stock"  in  the 
statement  of  an  American  bank.  But  in  practically  all 
instances  the  share  capitals  of  the  London  joint  stock  banks 
are  only  partly  paid  up.  This  is  English  custom  for  banks 
and  is  in  distinct  contrast  with  custom  and  with  legal 
requirements  in  the  United  States.  Thus  the  London 
County  and  Westminster  has  a  subscribed  capital  stock  of 
£14,000,000  par  value  (700,000  x  £20),  but  each  subscriber 
paid  in  only  25%   of  the  par  of  his  shares,  so  that  the 

io  Statement  slightly  abridged  from  one  to  be  found  in  the  London 
Economist,  Banking  Number,  Oct.  18,   1913,  p.  814. 
*  Given   in  the  original  statement  in  four  separate  classes. 


FOREIGN  MONEY  MARKET  FACTORS  211 

paid-up  capital  is,  as  indicated,  £3,500,000.  The  unpaid 
balance,  £11,500,000  in  this  instance,  may  be  called  from 
the  shareholders  if  this  action  should  become  necessary  to 
satisfy  the  claims  of  the  creditors  of  the  bank.  This  assess- 
able balance  due  on  the  subscribed  capital  is  the  last  line 
of  defense  which  a  joint  stock  bank  has  against  failure 
to  pay  its  creditors  in  full. 

In  the  case  of  many  of  the  banks,  the  unpaid  balance  is 
divided  into  two  parts  referred  to  respectively  as  ' '  callable ' ' 
and  "reserved."  To  explain  this,  there  are  two  grand  pur- 
poses for  which  a  company  might  demand  money  from  the 
shareholders  on  account  of  the  unpaid  balance.  One  pur- 
pose is  the  development  or  expansion  of  the  business,  the 
other  the  payment  of  the  claims  of  creditors  of  the  company, 
which  the  assets  do  not  suffice  to  meet.  The  entire  unpaid 
balance  on  the  shares  is  always  assessable  for  the  latter 
purpose.  This  is  determined  by  the  legal  principles  govern- 
ing the  liability  of  corporation  shareholders.  Where  the 
division  of  the  unpaid  balance  into  "callable"  and  "re- 
served" is  in  effect,  the  part  (or  it  might  be  the  whole) 
entitled  "reserved"  may  not  be  called  for  the  mere  purpose 
of  business  development,  being  reserved  for  the  sole  object 
of  paying  creditors  in  case  of  need ;  while  the  part  known  as 
"callable"  is  still  assessable  for  general  business  purposes, 
provided  of  course  proper  authority  within  the  corporation 
determines  upon  such  an  assessment. 

(2)  Reserve  is  the  item  known  as  "surplus"  in  the 
United  States.  The  Bank  of  England  has  its  own  peculiar 
name  for  this  account,  namely,  the  "Rest." 

(3)  Current  and  deposit  accounts. — The  deposit  liabili- 
ties of  English  banks,  using  the  word  deposit  in  the  broader 
sense  more  common  in  America,  are  separable  into  two 
chief  sub-divisions:  (a)  "current  accounts"  and  (b)  "de- 


212  I'oUKKiN    KX CHANGE 

posil  accounts."  The  first  are  deposits  payable  on  demand 
and  Bubjecl  to  check,  and  are  commonly  non-interest-bear- 
ing. They  are  the  English  equivalent  of  our  American 
commercial  deposits  or  checking  accounts.  The  second, 
often  referred  to  as  "deposits  at  notice,"  are  accounts 
which  the  customer  may  withdraw  only  after  giving  notice 
(of  a  week  or  two),  and  upon  which  the  bank  pays  interest, 
at  a  deposit  allowance  rate.  The  American  savings  deposit 
has  some  similarity  to  the  London  deposit  at  notice,  but 
the  notice  which  the  American  bank  may  require  is  usually 
for  a  much  longer  period — as  sixty  da3rs  perhaps — and 
the  rate  of  interest  is  higher  here.  Also  the  London  de- 
posits at  notice  are  not  invested  in  the  same  way  as  our 
savings  deposits. 

(1)  Circular  notes,  letters  of  credit,  etc. — This  account 
contains  miscellaneous  liabilities,  but  the  heading  "circular 
notes"  and  "letters  of  credit"  covers  travelers'  forms  of 
exchange  sold  by  the  bank  and  at  present  outstanding. 

(5)  Acceptances  for  customers. — This  item  shows  the 
amount  of  long  bills  of  exchange  which  have  been  drawn 
upon  this  bank  by  arrangement  with  it,  and  which  have  been 
accepted  by  it  and  are  now  outstanding  and  unpaid.  The 
drawers  of  these  bills  may  be  either  merchants  or  other 
banks.  Drafts  under  commercial  letters  of  credit  come 
under  this  account.  The  act  of  acceptance  makes  the  Lon- 
don County  and  AVestminster  Bank  unconditionally  liable 
to  pay  the  bills  at  maturity,  and  hence  the  liability  so 
created  is  entered  in  its  balance  sheet,  though  it  is  counter- 
balanced by  the  equal  liability  of  customers  to  provide  funds 
for  the  payment  of  the  acceptances  at  maturity — see  item 
number  14  beneath — protected  by  collateral  security. 

(6)  Endorsements  on  bills  negotiated. — This  item  shows 
the   conditional  or  secondary  liability    (compare   §  12   of 


FOREIGN  MONEY  MARKET  FACTORS  213 

this  book)  of  the  bank  as  indorser  of  any  bills  which  it  has 
indorsed  and  negotiated,  and  which  are  as  yet  unpaid  and 
unextinguished.  This  item  is  counterbalanced  by  number 
15  below.  Payment  of  such  a  bill  will  remove  it  from  both 
account  6  and  account  15. 

(7)  Rebate  on  bills  not  due. — The  second  largest  item 
of  assets  shown  in  the  balance  sheet  now  before  us,  number 
11,  is  "bills  discounted"  .  .  .  £18,340,178.  This  shows 
that  the  bank  now  holds  long  bills  which  have  a  total  face 
or  maturity  value  of  this  amount.  As  an  asset  strictly 
valued,  these  bills  are  worth  to  the  bank  at  the  present 
moment,  not  the  sum  of  their  full  face  values,  but  only  the 
sum  of  their  present  values.  Items  7  and  11  taken  together 
show  the  following  facts:  the  bank  now  holds  long  bills  of 
a  value  at  their  maturities  of  £18,340,178,  the  total  amount 
of  discount  on  all  these  to  be  deducted  to  find  their  present 
values  being  £94,741,  so  that  the  present  value  of  the  entire 
lot  of  bills  is  £18,245,437.  This  state  of  facts  might  be 
exhibited  by  the  entry  of  the  last  given  figure  as  a  single 
item  of  assets,  but  more  information  is  conveyed  by  giving 
the  two  items.  Item  number  7  of  the  liabilities  exists  only 
to  be  set  off  against,  or  subtracted  from,  item  number  11 
of  the  assets. 

(8)  Profit  and  loss  account. — This  is  the  same  as  "undi- 
vided profits, ' '  American  usage.  Items  of  liability  numbers 
1,  2,  and  8,  taken  together  constitute  the  total  of  capital, 
surplus,  and  undivided  profits  and  represent  the  share- 
holders' "equity"  or  the  total  net  business  capital  of  the 
proprietors  of  this  bank  employed  in  its  business. 

Items  on  the  Assets  Side 

The  chief  items  of  assets,  numbers  9  to  13,  appear  prac- 
tically in  the  order  of  their  "quickness,"  running  from  the 


214  FOREIGN  EXCHANGE 

most  liquid  to  tin1  less  liquid.  They  have  been  likened  to 
successive  lines  of  defense  to  be  fallen  back  upon  in  case 
of  unexpected  demands  from  the  creditors  of  the  bank. 

(9)  Cash  in  hand  and  at  the  Bank  of  England. — Tbis  is 
the  American  "reserve"  or  "cash  reserve."  "Cash  at  the 
Bank  of  England"  does  not  mean  a  special  deposit  of  actual 
gold  kept  in  the  strong  vaults  of  this  institution  for  safety, 
but  means  merely  an  ordinary  deposit  claim.  The  concep- 
tion of  a  reserve  consisting  in  a  deposit  credit  with  some 
central  bank  is  now  too  familiar  to  require  comment.  At 
present  writing  there  is  but  one  London  bank  whose  pub- 
lic reports  state  separately  the  amount  of  cash  in  its  own 
vaults  and  the  amount  with  the  Bank  of  England.  This 
is  the  Union  of  London  and  Smith's  Bank. 

(10)  Cash  at  call  and  short  notice. — "Cash  at  call" 
signifies  what  are  styled  call  loans  in  America.  In  London 
they  also  bear  the  name  of  "day  to  day"  loans.  They 
are  characterized  by  the  right  of  either  borrower  or  lender 
to  terminate  the  loan  on  (substantially)  a  day's  notice. 
In  New  York  call  loans  are  made  almost  wholly  to  dealers 
in  stocks,  in  London  almost  wholly  to  dealers  in  bills  of 
exchange  (compare  §§55  and  59  below).  Money  placed 
by  the  joint  stock  banks  with  the  people  of  the  London  stock 
market  is  loaned  generally  for  a  period  of  two  weeks,  this 
being  the  time  which  elapses  between  the  so-called  settle- 
ments on  the  London  Stock  Exchange.  The  New  York  Stock 
Exchange  settles  daily.  The  joint  stock  bank's  loans  to  bill 
brokers  are  made  largely  against  bills  as  collateral,  but  also 
against  bonds  and  stocks.  Loans  to  stock  dealers  are 
against  bonds  and  stocks  as  collateral  both  in  London  and 
New  York. 

(11)  Bills  discounted. — This  account  has  been  spoken 
of  already  in  connection  with  item  of  liabilities  number  7. 


FOREIGN  MONEY  MARKET  FACTORS  215 

The  greater  London  banks  do  not  make  a  practice  of  re- 
selling bills  which  they  have  once  bought.  In  other  words 
they  do  not  rediscount.11  Therefore  in  practice  it  is  not 
so  much  because  the  bills  on  hand  are  marketable  for  cash 
that  they  are  to  be  regarded  as  a  liquid  asset,  but  it  is 
rather  because  there  is  a  certain  portion  of  them  falling 
due  or  maturing  each  day.  If  the  bank  feels  the  need  of 
realizing  cash  for  its  reserve  from  the  resources  in  the 
portfolio  of  bills,  it  may  do  so  by  refraining  from  putting 
out  into  bills  again,  the  money  which  it  collects  from  day 
to  day  from  the  maturing  bills. 

(12)  Investments,  consisting  regularly  of  high  grade, 
readily  marketable,  interest-bearing  securities,  require  no 
special  comment  here. 

(13)  Advances  to  customers  and  other  accounts. — This 
entry  covers  the  great  mass  of  advances  or  loans  made  by 
the  bank  for  various  periods  on  personal  and  collateral 
security,  primarily  to  its  own  customers  direct.  It  includes 
the  main  body  of  advances  other  than  those  made  by  way 
of  the  purchase  of  bills  of  exchange  and  the  placing  of 
short  term  money  already  accounted  for.  This  is  the 
greatest  item  among  the  bank's  resources,  and  interest 
from  this  account  is  the  largest  element  in  the  bank's  earn- 
ings. 

(14)  Liability  of  customers  for  acceptances. — The  fifth 
account  showed  that  the  bank  was,  at  the  time  of  this  state- 
ment, liable  as  acceptor  on  £7,158,931  of  long  bills.  But 
these  instruments  were  all  accepted  at  the  request  of  "cus- 
tomers," and  the  latter  are  in  all  cases  under  contract  to 
provide  the  bank  with  the  funds  required  to  discharge  them. 

ii  Compare  pp.  218,  n.   15,  and  242. 


•Jit;  FOREIGN  EXCHANGE 

The  obligation  of  these  customers  thus  to  pay  over  £7,158,- 
931  is  a  resource  of  the  bank  and  is  here  entered  as  such. 
"Customers"  will  in  this  case  include  other  banks.  In 
fact  the  parties  that  have  made  arrangements  for  accept- 
ances may.  according  to  the  nature  of  their  relation  to  the 
bank,  be  divided  into  three  classes.  (1)  There  are  English 
importers  who  have  induced  the  bank  to  authorize  drafts 
upon  itself  to  be  drawn  by  merchants  who  are  to  make  ex- 
ports to  them  (compare  §37).  (2)  Then  there  are  banks 
foreign  to  England  which  have  authorized  exporters  in 
various  parts  of  the  world  to  draw  on  this  London  bank  at 
the  time  of  making  their  shipments.  Such  shipments  are 
not  necessarily  to  England  (compare  §38).  The  banks 
in  question  have  issued  their  sterling  letters  of  credit  and 
are  obligated  to  supply  the  London  bank  with  the  funds 
necessary  to  pay  the  bills  it  has  accepted  under  these  letters. 
The  importing  merchants  who  applied  for  the  letters  are 
in  turn  liable  to  reimburse  the  banks  which  wrote  them 
(compare  §41).  (3)  Finally,  there  will  be  foreign  banks 
which  have  themselves  drawn  long  bills  on  the  London 
bank  and  are  likewise  liable  to  it  for  the  funds  to  discharge 
them  at  maturity.  We  first  encountered  these  bills — 
bankers'  sixty  and  ninety  days'  drafts — in  the  foreign  ex- 
change market  reports  given  in  §  23.  "We  shall  learn  more 
of  them  later. 

(15)  Bills  negotiated  as  per  contra. — This  entry  was  ex- 
plained in  connection  with  number  6. 

(16)  Bank  and  other  premises. — This  entry  shows  the 
appraised  or  book  value  of  the  real  estate  holdings  of  the 
bank. 

The  principal  lines  of  business  followed  by  the  London 
joint  stock  bank  may  now  be  summarized : 


FOREIGN  MONEY  MARKET  FACTORS  217 

(1)  It  receives  deposits  on  demand  and  at  short  notice. 

(2)  It  makes  the  following  chief  types  of  loans  or  ad- 

vances : 

(a)  It  makes  loans  on  call  and  for  short  periods  to 

bill  brokers  and  discount  houses. 

(b)  It  makes  advances  by  discounting  long  bills, 

bought  partly  from  bill  brokers,  partly  from 
foreign  banks  which  use  it  as  correspondent, 
partly  from  its  own  mercantile  customers. 

(c)  It  makes  loans,  usually  for  periods  of  a  fort- 

night, to  dealers  in  the  London  stock  exchange. 

(d)  It  makes  loans  direct  to  its  own  mercantile  cus- 

tomers or  depositors. 

(e)  It  places  loans  at  times  in  foreign  money  capitals 

through  an  agent  or  correspondent  (compare 
§83  below). 

(3)  It  accepts  a  great  many  long  bills  of  exchange  drawn 

upon  itself,  thus  ''lending  its  credit." 

(4)  It  serves  as  correspondent  for  foreign  banks  dealing 

in  exchange. 

The  foregoing  list  does  not  include  what  the  British  would 
call  dealings  in  ' '  foreign  exchange, ' '  for  by  this  phrase  they 
would  mean  dealings  in  bills  drawn  (or  at  least  negotiated) 
in  England  that  are  payable  in  some  country  foreign  to 
England.  The  joint  stock  banks  have  much  to  do  with  bills 
of  foreign  origin  payable  in  sterling  in  England,  but  the 
English  banker  does  not  ordinarily  think  of  these  bills  as 
being  foreign  exchange,  for  the  reason  that  when  he  comes 
into  contact  with  them  they  are  already  in  England  and 
are  payable  there.  Until  recent  times  the  joint  stock  banks 
have  had  very  little  concern  with  what  the  Londoner  would 
speak  of  as  foreign  exchange,  but  they  are  now  beginning  to 
take  it  up.  Two  of  them  (as  far  as  discovered  by  the 
writer),  the  London  County  and  Westminster  and  the  Lon- 


•J IS  KOWKHiX    KXCHANGE 

don  City  and  Midland,  established  regular  foreign  depart- 
ments a  few  years  since,1-  and  the  same  two  have  more  re- 
cently made  arrangements  to  open  branches  in  Spain.13 

§  55.  The  bill  brokers  and  discount  houses. — In  London 
there  are  two  classes  of  dealers  in  bills  whose  business 
activities  are  confined  almost  exclusively  to  operations  in 
this  type  of  paper.  These  are  (1)  the  bill  brokers  and 
(2  I   the  discount  houses. 

The  original  or  so-called  ''running"  broker,  now,  accord- 
ing to  Mr.  Hartley  Withers,14  comparatively  rare  in  Lon- 
don, was  a  functionary  who  searched  out  those  with  bills 
or  notes  for  sale  and  those  ready  to  buy  them,  carried  the 
instruments  from  seller  to  buyer,  and  performed  this  service 
for  a  commission.  But  in  the  British  metropolis  the  domi- 
nant type  of  bill  broker  of  the  present  clay  actually  pur- 
chases and  resells  the  paper  which  passes  through  his  hands. 
He  buys  sterling  bills  from  local  mercantile  drawers,  and 
from  foreign  banks  with  offices  or  correspondents  in  Lon- 
don, and  from  such  other  banking  houses  as  make  a  practice 
of  selling  bills  which  they  have  once  bought.  Some  of 
the  larger  banks  make  it  a  rule  never  to  sell  a  bill  which 
has  come  into  their  own  ownership — though  they  sell  as 
agents  of  foreign  banks.  They  wait  till  maturity  for  real- 
ization upon  it,  and  appear  to  regard  the  maintenance  of 
this  policy  as  a  sign  of  superior  strength  and  a  point  of 
pride.15     These  banks,  however,  buy  bills  from*  the  broker 

12  Hartley  Withers,  "The  English  Banking  System,"  already  cited, 
p.  40. 

13  London  Economist,  for  February  10,  1917,  p.  222. 
i*  Compare  his  "Meaning  of  Money,"  pp.  139-141. 

is  Sir  Felix  Sinister,  Governor  of  the  Union  of  London  and 
Smith's  Bank,  made  the  following  statement  (in  the  year  1908  or 
1909),  "As  far  as  I  am  aware  this  bank  has  never  as  long  as  it 
has  been  in  existence  had  one  penny  from  the  Bank  of  England, 
whether  by  way  of  an  advance  or  by  way  of  a  rediscounted  bill. 
We  do  not  rediscount  our  bills  in  the  market  either,  so  every  trans- 


FOREIGN  MONEY  MARKET  FACTORS  219 

freely  and  also  lend  him  much  money  for  his  operations,  so 
they  are  in  constant,  though  one-sided,  business  relations 
with  him. 

The  rate  of  discount  named  by  the  bill  brokers  as  the  basis 
of  their  purchases  of  any  given  class  of  bills  is  known  as 
the  "market  rate"  for  this  class.  When  banks  buy  bills 
from  their  ordinary  customers,  private  persons  or  foreign 
banks  which  have  them  as  correspondents,  they  likewise 
exact  this  same  market  rate.  But  when  they  buy  the  same 
instruments  from  the  brokers,  as  distinguished  from  ordi- 
nary customers,  they  shade  the  market  rate  b}7  about  Vs 
or  Vi%.  The  broker  lives  upon  this  special  concession. 
We  shall  see  presently  why  it  is  open  to  him. 

The  following  table  shows  how  the  profit  made  by  the 
broker  on  an  individual  bill  may  be  calculated. 

THE  BROKER'S  PROFIT  ON  A  TURNOVER  OF  A 
£1,000  BILL 

Suppose  a  broker  purchases  a  £1,000  bill  with  93  days  to  run, 
on  the  basis  of  a  discount  rate  of  3V>%  per  annum,  and  sells  this 
hill  on  the  same  day  to  a  bank  at  a  discount  rate  of  3%%  per 
annum.     The  following  account  results: 

Broker's  purchase  price  of  bill 

One  year's  discount  =  3V//v  of  £1,000 

=  £35 
93  days'  discount  =  9%go  X  £35 

=  £8.918 
(For  the  sake  of  convenience  we  figure  in  pounds  and 

decimals  of  pounds  and  omit  shillings  and  pence.) 
Price  paid  by  broker  for  bill       =  £1,000  —  £8.918 

=      991.082 

action  we  enter  into  we  have  to  see  through  to  the  very  end."  "In- 
terviews," etc.,  as  already  cited,  p.  5.>.  A  practically  identical 
declaration  was  also  made  for  the  London  Joint  Stock  Bank  by  its 
general  manager.     Ibid.,  p.  71. 


220  FOREIGN  EXCHANGE 

Broker's  selling  /trice  of  bill 

One  year's  discount  =  3%%  of  £1,000 

=  £  33.75 

93  days'  discount  =  9%ee  X  £33-75 

=  £8.599 

Selling  price  to  bank       =  £1,000  —  £8.599 
=       991.401 

Broker's  profit 

Selling  price   991.401 

Buying  price  991.082 


.319 
£.319  is  about  6s.  5d.     This  profit  figures  at  about  the 
rate  of  Vzi  of  1%  of  the  broker's  temporary  invest- 
ment in  the  bill. 

The  broker  makes  in  this  case  a  profit  of  about  %2  of  1% 
on  the  turnover.  If  he  could  perform  this  operation  300 
times  a  year  with  the  capital  of  £991,  he  would  make  300 
times  %2  or  only  9%%  per  annum  for  his  capital  and  his 
own  trouble  and  risk.  This  capital  is  itself  largely  bor- 
rowed from  the  joint  stock  banks  on  call,  at  an  average 
interest  cost  under  the  conditions  of  this  example  of  say 
2^4%  per  annum.  The  broker's  net  interest  gain  is  then 
about  67/&%  per  annum.  These  figures  are  not  advanced  so 
much  as  giving  an  accurate  representation  of  the  actual 
average  gains  of  brokers  in  London,  as  by  way  of  showing 
the  manner  in  which  they  may  be  calculated. 

When  a  broker  bu3*s  a  bill  and  resells  it  to  a  bank,  he 
does  not  usually  place  his  indorsement  upon  the  instru- 
ment, but  he  does  nevertheless  in  common  practice  guar- 
antee that  the  bill  will  be  paid  at  maturity.  This  guarantee 
is  effected  by  his  giving  the  bank  a  continuing  contract 
which  covers  during  its  life  all  bills  rediscounted  with  the 
institution.     The  broker  may  sell  bills  to  the  same  bank 


FOREIGN  MONEY  MARKET  FACTORS  221 

from  which  he  borrows  funds  to  employ  in  the  bill  business. 
As  security  for  any  of  his  loans  from  a  bank  he  deposits 
collateral  consisting  of  first  class  bills  or  of  securities  of  the 
best  grade,  payable  to  bearer,  such  as  consols,  London  cor- 
poration bonds,  Indian  railway  bonds,  etc.  These  securi- 
ties are  of  the  tjqDe  called  "floaters"  in  London.  With 
respect  to  the  bills  deposited  as  collateral,  they  make  up< 
part  of  the  broker's  stock  on  hand,  and  if  he  desires  to  sell 
any  individual  one  of  these  bills  he  may  obtain  it  by  sub- 
stituting other  acceptable  collateral  or  by  paying  off  a  suffi- 
cient proportion  of  the  loan  to  release  it. 

Since  the  bill  brokers  operate  with  capital  borrowed  from 
the  banks  and  sell  bills  to  the  banks  under  a  specially 
favorable  rate,  and  thus  make  a  middleman's  profit,  the 
question  arises  why  the  banks  do  not  take  steps  to  eliminate 
the  brokers.  In  fact,  so  far  from  being  crowded  out,  the 
brokers  enjoy  "nearly  the  whole  of  the  better  class  of  busi- 
ness in  bills."  16  The  explanation  is  that  the  banks  usually 
have  a  greater  supply  of  funds  than  they  can  lend  to  their 
own  direct  customers  or  depositors,  and  they  find  it  advan- 
tageous to  place  some  of  the  surplus  in  bills  bought  from, 
the  brokers.  The  latter  spend  their  time  in  becoming  spe- 
cialists on  the  personal  credit  of  the  various  individuals 
and  firms  that  offer  bills  for  sale  in  the  market,  and  g<5 
about  gathering  the  instruments  up,  and  sell  them  with  a 
guarantee.  One  of  their  greatest  services  to  the  bank  is 
that  they  enable  it  to  purchase  selected  maturities  and 
thus  to  obtain  a  proper  marshaling  with  respect  to  due 
dates,  of  the  whole  body  of  bills  it  holds,  or  its  so-called 
portfolio  of  bills.  Special  circumstances  apart,  the  ideal 
portfolio  will  contain  a  body  of  bills  maturing  day  by  day 
in  substantially  equal  portions,  a  lot  falling  due  to-day, 
an  equal  one  to-morrow,  and  so  forward.     Tinder  this  ar- 

16  Clare,  "Money  Market  Primer,"  p.  141. 


1'oK'KKiN    KX CHANGE 

rangemenl  a  fraction  of  the  fund  invested  in  bills  will  be 
released  each  day:  no  special  need  for  cash  appearing  on 
the  day,  it  may  be  invested  again  in  new  bills.  But  the 
nature  of  the  hank's  business  makes  it  highly  desirable  that 
these  daily  releasings  of  funds  should  actually  take  place. 
Now  tlir  banker  may  discount  many  bills  for  his  own  de- 
positors. If  these  do  not  happen  to  be  marshalled  in  ex- 
act ly  the  right  manner  with  respect  to  maturities,  the 
broker  can  furnish  bills  with  such  due  dates  that  when  they 
are  added  to  those  already  on  hand  the  whole  portfolio  will 
mature  in  proper  sequence.  The  broker  deals  with  so  many 
banks  that  he  is  practically  able  to  select  from  his  stock  bills 
of  the  character  desired  by  the  particular  banking  customer. 
It  is  doubtful  whether  the  banks  could  supplant  the  broker 
with  advantage.  At  any  rate  they  do  not  do  so.  He  works 
on  capital  largely  borrowed  from  them  and  lives  on  a 
differential  granted  by  them,  but  he  appears  to  return  full 
value  in  services  for  these  concessions.17 

The  discount  house  differs  from  the  bill  broker  or  bill 
broking  firm  in  degree  rather  than  in  kind.  It  is  a  house 
with  a  larger  capital  which  makes  a  practice  of  holding  a 
greater  proportion  of  bills  till  their  maturities.  To  do  this 
it  must  employ  more  capital,  in  proportion  to  the  number 
of  bills  handled,  than  does  the  broker.  Historically  the 
discount  houses  are  outgrowths  of  the  bill  broking  firms. 
Most  are  partnerships,  but  there  are  now  (1919)  three  that 
are  incorporated,  or  "joint-stocked"  as  the  English  say. 
The  funds  employed  by  the  discount  house  consist  (1)  of 
its  own  capital,  (2)  of  interest-bearing  deposits  on  demand, 
(3)  of  interest-bearing  deposits  at  notice,  and  (4)  of  monies 
borrowed  from  the  joint  stock  banks  at  call  and  short 
notice.  It  is  a  little  though  not  altogether  like  a  savings 
bank  which  employs  its  depositors'  funds  in  the  purchase 

it  Compare  Straker,  "The  Money  Market,"  pp.  107-8. 


FOREIGN  MONEY  MARKET  FACTORS  223 

of  bills  instead  of  the  purchase  of  mortgages  and  long  term 
securities.  The  rate  of  interest  allowed  on  deposits  at  no- 
tice is  higher  than  upon  those  payable  on  demand. 

The  following  table,  from  a  report  of  some  j^ears  back 
of  the  National  Discount  Company,  will  throw  light  upon 
the  operations  of  a  discount  house. 

MARGINS  OF  DISCOUNT  IN  DISCOUNT  COMPANY'S 
FAVOR  18 

The  margins  in  our  favor  this  half-year,  compared  with  those 
of  the  corresponding  six  months  in  1909,  are  as  follows: 

1910  1909 


£       s       d  £       s       d 

Actual  discount  3       1     11  2       0       5 

Actual  deposit  interest  2    14      7  1     16      7 

Difference 

Actual  yield  on  investments 
Deposit  interest 

Difference 

Actual  loan  interest 
Deposit  interest 

Difference  18       5  1       3     10 

The  first  entry  "actual  discount  ...  £3  Is.  lid."  shows 
the  average  rate  of  discount  charged  by  the  company  in 
its  purchase  of  bills  during  the  first  half  of  the  year  1910, 
namely  the  rate  of  "three  pounds,  one  shilling  and  eleven 
pence  per  cent."     This  is  to  the  American  reader  an  un- 

is  From  the  half-yearly  report  of  the  National  Discount  Com 
pany,  Ld.,  July  15,  1910,  published  in  the  London  Economist,  .July 
16,  1910,  p.  127. 


7 

4 

3 

9 

11 

2 

14 

7 

15 

4 

4 

3 

0 

2 

14 

7 

3 

10 

3 

9 

6 

1 

16 

7 

1 

12 

11 

3 

0 

5 

1 

16 

7 

224  KOWKKiX   KXCIIAXYJE 

familiar  method  of  expressing  a  percentage  rate.  It  signi- 
fies the  Dumber  of  pounds,  shillings  and  pence  to  the  100 
pounds.  If  we  were  to  adopt  a  corresponding  usage,  we 
would  speak  of  a  rate  of  "three  dollars  and  twenty-five 
cents  per  cent"  where  we  now  say  31/4%.  That  is,  "three 
dollars  and  twenty-five  cents  per  cent"  would  mean  3M 
dollars  to  the  100  dollars,  or  simply  3%%.  £3  Is.  lid.  is, 
written  decimally,  £3.096,  and  "£3  is.  lid.  per  cent"  is, 
expressed  in  the  ordinary  fashion,  3.096%  or  39<Kooo%. 
The  Englishman  will  on  occasion  write  a  rate  of  31/£%  as 
' '  £3  10s.  per  cent, ' '  i.e.,  three  and  one-half  pounds  to  the 
100  pounds.  To  convert  any  rate  expressed  in  pounds, 
shillings  and  pence  to  one  formulated  in  the  usual  manner, 
it  is  merely  necessary  to  reduce  the  pounds,  shillings  and 
pence  to  pounds  and  a  decimal  fraction  of  a  pound. 

The  table  entitled  "margins  of  discount"  falls  into  three 
parts.  The  first  part  shows  that  in  the  earlier  half  of  1910 
the  company  earned  an  average  of  £3  Is.  lid.  of  discount 
per  annum  on  each  £100  of  capital  in  the  bill  business,  and 
that  so  much  of  this  capital  as  was  obtained  from  depositors 
cost  on  the  average  £2  14s.  7d.  of  interest  per  annum  per 
£100.  The  "difference"  of  7s.  4d.  is  the  company's  margin 
in  this  department  of  its  business.19  It  amounts  to  a  little 
more  than  %  of  1%.  The  second  part  of  the  table  shows 
that  funds  employed  by  the  company  in  investments,  or 
placed  by  it  in  interest-bearing  securities  other  than  bills 
or  notes,  yielded  £3  9s.  lid.  per  cent,  and  thus  a  margin 
of  15s.  4d.  or  one  a  little  better  than  %  of  1%.  From  the 
third  part  of  the  table  we  see  that  direct  loans  afford  a 
margin  of  £1  8s.  5d.  per  cent  or  1.42%.  It  appears  the 
discount  of  bills  is  the  least  remunerative  of  the  three  de- 
partments  of   the   business,   nevertheless   far   the   greater 

io  A  slight  error  is  involved  in  subtracting  an  interest  rate  from 
a  discount  rate,  but  it  is  in  the  case  of  such  low  rates  as  these 
practically  negligible. 


FOREIGN  MONEY  MARKET  FACTORS 


225 


portion  of  the  capital  controlled  by  the  company  is  invested 
in  them.  The  reason  for  the  preference  for  bills  is  that 
they  make  the  most  liquid  assets  to  carry  against  deposits  on 
demand  and  at  short  notice. 

Beneath  is  a  specimen  balance  sheet  of  a  discount  com- 
pany. 

Balance  Sheet 

UNION  DISCOUNT  COMPANY,  Ld.20 

June  30,  1912. 


Liabilities 

Capital— 150,000  £10 
shares,   £5   paid   up 

Reserve  fund    

Provident  reserve  fund 

Loans  and  deposits, 
including  provision 
for  contingencies  .  . 

Bills  rediscounted  .  .  . 

Rebate  on  bills  dis- 
counted     

Balance  at  credit  of 
profit  and  loss 
for  appropriation, 
£141,652;  less  trans- 
ferred to  reserve 
fund,  £15,000   


750,000 

650,000 

87,507 


18,326,937 
6,973,184 

161,262 


Assets 

Cash  at  bankers   .... 

British  Government, 
Indian  Government, 
and  other  securities 

Loans  on  securities  at 
call  and  short  date 
and   other   accounts 

Bills    discounted,    etc. 

Sundry  debt  balances 

Freehold  and  leasehold 
premises,  fittings 
and  furniture,  at 
cost,  less  deprecia- 
tion written  ofT  half- 
yearly    


!2,450 


2,853,318 


1,606,477 

21,579,852 

36,048 


117,397 


126,652 
27,075,542 


27,075,542 


An  item  entitled  loans  appears  on  both  sides  of  this  state- 
ment. Its  presence  on  the  side  of  liabilities  shows  that  the 
discount  company,  unlike  the  joint  stock  bank  or  the  ordi- 
nary commercial  bank  of  the  United  States,  is  a  literal 
borrower  of  money.21     Between  its  direct  borrowings  from 

20  From  the  London  Economist,  October  19,  L912,  p.  764. 
2i  The  commercial  bank  is  in  a  sense  a  borrower  of  the  funds  lift 
on  deposit  with  it,  but  there  is  a  great  practical  distinction  between 


226  FOREIGN  EXCHANGE 

others,  presumably  from  joint  stock  banks,  and  its  deposits 
received  from  individuals,  the  Union  Discount  Company 
was  on  June  30,  1912,  indebted  to  outside  parties  for  the 
enormous  capital  of  £18,000,000  employed  by  it  in  its  busi- 
ness. This  sum,  at  ordinary  rates  of  conversion  approxi- 
mately $89, 000,000,  is  nearly  twenty-five  times  its  share 
capital,  and  constitutes  practically  the  whole  of  its  work- 
ing funds.  On  the  side  of  assets  the  one  item  of  "bills 
discounted  .  .  .  £21,597,852"  is  unapproached  by  its  fel- 
lows. The  net  amount  of  bills  on  hand  is  £21,579,852  less 
£6,973,184  (bills  rediscounted,  appearing  among  the  lia- 
bilities), or  £14,606,668." 

How  much  more  important  the  business  of  discounting 
bills  is  to  the  discount  house  than  to  the  bank  appears  from 
the  figures  in  the  table  at  the  top  of  page  227. 

These  figures  fluctuate  to  a  degree,  of  course,  but  the  dif- 
ference in  the  composition  of  the  assets  of  the  two  classes  of 
institutions  is  most  pronounced.  The  fraction  of  the  total 
resources  invested  in  bills  is  in  the  case  of  the  discount 
houses  over  85%,  in  the  case  of  the  banks  about  10%.  Cer- 
tain other  banks  have  a  somewhat  higher  proportion  of 

being  a  borrower  in  this  sense  and  being  a  recipient  of  direct  and 
literal  loans. 

22  The  company  has  f  14,606,068  of  bills  on  hand,  and  there  are 
still  in  existence  unmatured  bills  which  it  once  hold,  but  which  it 
has  rediscounted  to  the  sum  of  £6,973,184.  The  latter  are  carried  as 
a  liability  because  the  company  is  a  "party  secondarily  liable"  on 
these  bills,  either  as  guarantor,  or  else  as  indorser.  That  is,  it  is 
liable  to  make  payment  on  these  bills  should  their  acceptors  fail 
to  pay.  If  the  company  should,  perchance,  be  forced  to  pay  these 
bills,  it  could,  of  course,  look  to  the  drawers,  other  indorsers,  and 
also  to  the  acceptors  themselves  for  reimbursement,  and  thus  these 
bills  would  then  become  at  this  stage  a  resource  of  the  company. 
Thus,  if  bills  rediscounted  are  carried  as  contingent  liabilities,  they 
are  also  properly  carried  as  contingent  resources.  The  form  of  state- 
ment adopted  here  merely  conveys  fuller  information  than  it  would 
if  the  item,  £0,973,184,  were  omitted  from  both  sides. 


FOREIGN  MONEY  MARKET  FACTORS 


227 


CLASSIFICATION  OF  ASSETS  OF  DISCOUNT  HOUSES 

AND  JOINT  STOCK  BANKS  23 

(December  31,  1913) 


B 

a    B 
.2    ^ 
3  .2 

O      o 

Is  .2 

d 

a,   U 

1-4 

"S  c 

cS     o 
!*!     u 

<  s 

SI 

►J  pq 

3* 

% 

% 

% 

% 

% 

Cash  at  bankers 

2.8 

2.2 

2.4 

Cash  in  hand  and  at  Bank 

of    Eng 

15.1 

15.9 

Cash   at   call   and   at    short 

3.0 

2.9 

2.6 

8.1 

11.0 

Investments   in   securities    . 

7.0 

8.0 

7.7 

9.8 

7.2 

Bills    discounted    

86.7 

86.0 

87.3 

10.2 

10.8 

Loans  and  advances    

47.8 

47.3 

0.5 

0.9 

9.0 

7.8 

100. 

100. 

100. 

100. 

100. 

assets  carried  in  bills.  In  addition  to  the  three  incorpo- 
rated discount  houses  there  were  in  1910  about  twenty 
private  firms  engaged  in  the  same  business  as  these.24 

§  56.  The  branches  of  foreign  and  colonial  banks. — There 
are  at  present  (end  of  year  1918)  43  joint  stock  banks, 
exclusive  of  the  Bank  of  England,  which  employ  their 
capitals  wholly  or  primarily  in  the  United  Kingdom. 
Twenty-six  are  located  in  England,  8  in  Scotland,  and  9  in 
Ireland.  The  English  banks  have  collectively  6,285 
branches,  and  in  round  numbers  the  Scotch  have  1,250  and 
the    Irish   850.2n     A    greatly   preponderating    pari    of    the 

23  Compiled  from  data  to  be  found  in  the  London  Economist, 
Banking  Number,  May  23,  1914,  pp.   1212  and  1223. 

24  See  statement  of  manager  of  the  Union  Discount  Company  in 
"Interviews,"  etc.,  already  cited,  p,    L04. 

25  See  the  London  Economist's  Banking  Number,  May  17,  1919, 
p.  823. 


228  FOREIGN  EXCHANGE 

capital  of  this  entire  group  of  institutions  is  controlled  in 
London  and  employed  there,  and  the  remainder  is  almost 
all  represented  in  London,  through  branches,  agencies  or 
correspondents,  in  such  a  maner  as  to  be  a  factor  in  the 
discount  market  of  that  city.  Important  activities  in  this 
market  are  also  undertaken  by  a  large  number  of  great 
incorporated  banks  which  have  branches  in  London,  though, 
their  main  fields  of  operation  are  scattered  over  the  world 
beyond  the  confines  of  the  United  Kingdom.  From  Lon- 
don's standpoint  these  institutions  are  divisible  into  the 
two  classes  of  (1)  the  colonial  and  (2)  the  foreign  banks. 

The  table  beneath  shows  some  of  the  more  important 
facts  pertaining  to  the  colonial  banks. 

COLONIAL  BANKS  WITH  LONDON  BRANCHES  OR 
OFFICES 

Number  Capital, 

of  Surplus  and  Total  of  Assets  or  Liabilities 

branches  Undiv.  Profits             In  £  In  $ 

African                      7                547  £14,607,000  102,000,000  495,000,000 

Australasian            18             2,297  42,385,000  208,000,000  1,300,000,000 

Canadian                   7             1,439  24,788,000  223,000,000  1,082,000,000 

Indian                        5                 91  8,097,000              66,000,000  320,000,000 

Totals  37  4,374  £89,877,000  659,000,000  3,197,000,000 

Notes: — (1)    Some    of    these    banks    have    their    "main    offices"    in 
London,  but  in  all  cases  the  chief  field  of  business  is  in  the  colonies. 

(2)  Pounds    are    converted    to    dollars    at    the    ratio    of    £1  =  $4.85. 

(3)  This  table  is  condensed  from  one  compiled  by  the  London 
Economist  for  Oct.  21,  1916,  p.  710,  from  the  latest  balance  sheets 
of  the  banks  available  at  that  time. 

As  a  matter  of  interest  the  names  of  a  number  of  the 
greater  colonial  banks  are  given,  with  the  totals  of  their 
assets  as  shown  in  the  latest  balance  sheets  available  on 
May  17,  1919. 

CERTAIN  GREATER  COLONIAL  BANKS 

Total  of  assets  in  £s. 

1.  Bank  of  Montreal 114,900,000 

2.  Canadian  Bank  of  Commerce 90,500,000 

3.  Royal  Bank  of  Canada 88,000,000 


FOREIGN  MONEY  MARKET  FACTORS  229 

Total  of  Assets  in  £s. 

4.  Bank  of  New  South  Wales 62,100,000 

5.  Standard  Bank  of  South  Africa 50,300,000 

6.  Chartered    Bank    of    India,    Australia    and 

China 47,600,000 

7.  Commonwealth  Bank  of  Australia 47,200,000 

8.  National  Bank  of  South  Africa 46,000,000 

9.  Bank  of  New  Zealand 40,800,000 

10.  Bank  of  Australasia 31,600,000 

11.  Union  Bank  of  Australia 31,300,000 

The  semi-annual  Banking  Number  of  the  London 
Economist  gives  the  latest  procurable  balance  sheets  of  the 
various  foreign  incorporated  banks  that  have  London 
branches  or  offices.  Examination  of  the  issue  of  May  19, 
1917,2G  shows  that  there  were  at  the  time  34  such  institu- 
tions. The  total  of  the  assets  (or  liabilities)  of  these  banks 
is  given  below.  Conversions  into  sterling,  where  necessary, 
are  made  at  rates  of  exchange  normal  or  usual  just  before 
the  war. 

FOREIGN  BANKS    (i.e.,  not  located   in  the  British  Empire) 
WITH  LONDON   OFFICES 

Total  of  Assets  in  £s. 
18  European    banks    in    allied    or 

neutral  countries    877,800,000 

7  South  American  banks 121,600,000 

5  Banks  in  the  Orient 103,800,000 

4  Banks  in  the  United  States 218,500,000 

Total    1,321,700,000  ($6,410,000,000) 

Were  it  not  for  the  war  we  should  be  able  to  counl  in 
five  banks  of  the  Central  Empires,  which  had  at  the 
beginning  of  1914  combined  total  resources  of  about 
£316,600,000. 

20  The  latest  issue  containing  the  data  in  convenient  form. 


230  KnWKKiN    K.\<  1 1  A  \<  I  K 

The  four  American  institutions  having  branch  offices  in 
London  are: 

Total  assets  in  £.  (1917) 

The  Guarantee  Trust  Company 117,700,000 

Equitable    Trust    Company 46,400,000 

Farmers  Loan  and  Trust  Company 42,000,000 

International  Banking  Corporation 12,400,000 

Summary : 

34  Foreign  Banks  with  London  Offices...   1,321,000,000 
37  Colonial  Banks  with  London  Offices. . .      659,000,000 


Total    £1,980,000,000 

Interpreting  this  colossal  figure,  we  should  take  heed  of 
certain  warnings.  In  the  first  place,  the  £1,980,000,000 
constitute,  not  the  proprietory  capital  of  these  institutions 
(namely  paid-up  capital  plus  surplus  and  undivided 
profits)  but  constitute  their  entire  assets.  The  proprietory 
capital  would  be  perhaps  one-eighth  as  large.  The  next 
caution  has  reference  to  a  particular  circumstance  of  the 
present  war.  Since  the  beginning  of  this  conflict  a  great 
expansion  of  bank  credit  has  taken  place  in  most  parts 
of  the  world  and  the  total  assets  of  almost  any  system  of 
banks  will  be  found  to  be  much  inflated  as  compared  with 
those  of  the  year  1914.  A  final  consideration,  more  general 
in  character  and  more  important  in  the  present  connection, 
is  that  these  huge  resources,  though  represented  in  London, 
are  not,  of  course,  in  the  main  invested  or  employed  there. 
An  unknown  but  certainly  small  percentage  of  them  are 
employed  in  London  at  any  one  time.  Nevertheless  the 
London  branches  of  these  banks  serve  as  gateways  to  the 
London  money  market  and  tend  to  augment  both  the  de- 
mand for  and  the  supply  of  loanable  funds  which  come 
together  there.  The  relation  of  these  banks  to  London 
tends  also  to  maintain  the  custom  of  settling  commerce  by 


FOREIGN  MONEY  MARKET  FACTORS  231 

means  of  sterling  drafts  and  thus  to  sustain  London  in  its 
dominant  position  as  financier  of  the  trade  of  the  globe. 

It  is  not  to  be  forgotten  that  a  vast  number  of  banks 
have  almost  if  not  quite  as  intimate  contact  with  the  Lon- 
don bill  market  through  their  correspondents,  even  if  they 
possess  no  London  offices  of  their  own.27  There  are  also 
not  a  few  private  banking  houses  with  London  agencies, 
or  with  joint  accounts  or  other  similar  arrangements  with 
local  British  private  bankers,  which  enter  into  the  English 
monej-  market.  Examples  from  the  United  States  are  J.  P. 
Morgan  &  Company  of  New  York  coupled  with  Morgan, 
Grenfell  &  Co.  of  London  (and  also  with  Morgan,  TIarjes 
&  Co.  of  Paris)  ;  Brown  Brothers  &  Co.  of  New  York  with 
Brown,  Shipley  &  Co.  of  London ;  August  Belmont  &  Co. 
of  New  York  with  Messrs.  Rothschild  of  London,  Paris,  and 
Vienna;  Lee,  Higginson  &  Co.  of  Boston  with  Higginson 
&  Co.  of  London. 

§  57.  The  Bank  of  England. — The  famous  establishment 
known  as  the  Bank  of  England  consists  of  two  very  distinct 
divisions  called  the  "issue  department"  and  the  "banking 
department."  The  first  named  has  entire  charge  of  the 
issue  and  redemption  of  Bank  of  England  notes,  and  this 
is  its  only  function.  On  a  recent  date,  May  16,  1917,  there 
were  £70,971,155  of  these  notes  outstanding  and  the  issue 

27  During  the  years  1917  and  1918  a  number  of  important  amalga- 
mations between  London  banks  took  place.  The  result  lias  been  at 
this  date  (May,  1919)  to  leave  live  gigantic  institutions  far  in  the 
lead  of  all  others,  now  called  the  big  five. 

The  list  of  these  follows  with  the  total  of  their  assets  or  liabili- 
ties according  to  the  latest  balance  sheets  to  be  found  at' the  time  of 
writing. 

London  Joint  City  and  Midland    £363,500,000 

Lloyds  Bank    300,700,000 

London  County  Westminster  &.  Parr's   287,500,000 

Barclay's    Bank    258,000,000 

National  Provincial  and  Union   Bank  of  England    215,600,000 


232  FOREIGN  EXCHANGE 

department  possessed  just  £70,971,155  of  assets  to  cover 
them,  and  these  constituted  all  the  assets  it  had.  A  com- 
mon assumption  is  that  the  resources  of  the  issue  depart- 
ment are  especially  pledged  for  the  payment  of  notes  alone, 
but  the  Law  is  not  explicit  on  this  point,  and  Mr.  George 
('hire  states  that  "good  authority"  has  held  that  should  the 
bank  fail  the  assets  of  the  issue  department  would  become 
a  part  of  the  general  fund  of  resources  against  which 
depositors  and  note-holders  would  have  merely  equal 
claims.28 

The  assets  held  by  the  issue  department  fall  into  two 
parts,  (1)  gold  coin  and  bullion  (amounting  to  £52,521,155 
on  May  16,  1917),  and  (2)  British  government  debt  and 
other  securities  (amounting  to  £18,450,000).  In  conse- 
quence, the  entire  circulation  of  the  bank  is  thought  of  as 
divided  into  the  two  parts  known  as  the  "covered"  and 
the  "uncovered  issue."  On  May  16,  1917,  the  issue  was 
constituted  as  follows: 

Covered  issue   £52,521,155 

Uncovered  issue  18,450,000 

Entire  circulation    70,971,155 

The  uncovered  issue  is  not  without  protecting  assets  but 
is  uncovered  so  far  as  specie  is  concerned. 

Under  the  law  governing  the  bank — the  Peel  Act  or  Bank 
Act  of  1844 — the  uncovered  part  of  the  issue  is  intended 
to  be  an  unchangeable  quantity  with  the  exception  that 
it  may  be  expanded  at  the  time  when  any  of  the  few  re- 
maining country  banks  now  possessing  the  circulation 
privilege  surrender  it.  In  the  event  of  such  a  surrender 
the  Bank  of  England's  uncovered  issue  may  be  increased 

28  "Money  Market  Primer,"  2d  ed.,  p.  17.  Mr.  Clare  says,  "Though 
interesting  in  theory,  the  question  is,  of  course,  of  no  practical 
importance." 


FOREIGN  MONEY  MARKET  FACTORS  233 

by  two-thirds  of  the  amount  surrendered.  The  final  maxi- 
mum to  which  it  can  attain  under  this  law  will  be  £19,616,- 
000.  The  Peel  Act  was  drawn  in  contemplation  of  the  ulti- 
mate extinguishment  of  all  issues  except  that  of  the  Bank 
of  England,  and  in  contemplation  of  the  fixity  of  the  un- 
covered part  of  the  issue  of  this  institution.  There  is,  how- 
ever, a  proceeding  in  England  known  as  the  Suspension  of 
the  Bank  Act  which  has  the  purpose  of  enabling  the  bank 
to  expand  the  uncovered  part  of  its  issue  in  times  of  acute 
crisis,  irrespective  of  the  disappearance  of  any  country 
circulation.     We  shall  speak  of  this  again  presently. 

In  normal  times — and  this  means  practically  all  the 
time,  since  the  Bank  Act  is  very  rarely  suspended — the 
fluctuations  in  the  total  outstanding  circulation  take  place 
solely  in  the  shape  of  the  expansion  or  contraction  of  the 
"covered"  part  of  the  issue.  Notes  are  in  regular  course 
paid  out  by  the  issue  department  only  in  exchange  for  gold, 
and  they  are  retired  only  upon  redemption  in  gold.  Since 
the  covered  notes  to-day  constitute  almost  three-quarters 
of  the  whole  circulation,  and  since  the  retirement  of  notes 
by  the  public  in  such  volume  as  to  reach  the  uncovered  part 
is  hardly  within  the  range  of  practical  possibility,29  the 
Bank  of  England  note  is  in  its  practical  aspects  a  gold 
certificate.  Suppose  the  United  States  government  had 
$1,200,000,000  of  gold  certificates  outstanding,  and  should 
with  the  consent  of  their  holders  remove  about  $300,000,000 
of  the  gold  carried  in  the  special  trust  fund  reserve,  and 
substitute  an  equal  amount  of  its  own  bonds  payable  in 
gold.  This  would  make  the  gold  certificate  very  similar  to 
the  Bank  of  England  note  as  that  instrument  is  to-day.30 

2»  At  no  time  when  the  Bank  of  England  has  been   in  difficulties 

has  there  been  the  slightest  run  upon  the  issue  department  as  sueh 
based  upon  suspicion  of  the  bank's  note. 

so  The  law  permits  the  issue  department  to  include  in  the  Bpecie 
held  to  cover  the  notes,  a  one-fifth  proportion  of  silver  coin,  but  the 


234  FOREIGN  EXCHANGE 

Tin-  banking  department  keeps  its  own  separate  cash 
reserve,  chiefly  in  the  form  of  notes  of  the  issue  department. 
It  has  to  give  up  or  forego  gold  to  obtain  these  notes  and 
holds  them  instead  of  gold  for  the  same  reason  of  conven- 
ience that  leads  our  American  banks  to  keep  so  large  a  pro- 
portion of  their  gold  reserves  in  the  form  of  gold  certificates. 
On  -May  16,  1917,  the  banking  department  held  £32,456,660 
of  notes  as  cash,  and  there  were  therefore  but  £38,514,495 
of  notes  held  by  the  outside  public.  In  many  cases  the 
figure  given  by  statisticians  as  "the  circulation"  of  the 
bank  is  merely  that  for  the  notes  held  by  the  outside  public. 

Bank  of  England  notes  are  issued  in  denominations  of 
£5,  10,  20,  50,  100,  200,  500  and  1000.  They  are  legal 
tender  in  England  and  "Wales  but  not  in  Scotland  or  Ire- 
land. They  are  not  legal  tender,  however,  when  proffered 
in  payment  by  the  Bank  of  England  itself,  or  as  the  law 
says  "at  the  bank."  Prior  to  the  present  war  they  were 
the  only  legal  tender  paper  of  the  United  Kingdom,  but  in 
August  1914  the  British  government  issued  its  own  new 
"Currency  Notes"  in  denominations  of  10  shillings  and  also 
of  £1,  with  the  legal  tender  power.  These  currency  notes 
are  still  outstanding  in  large  volume  (£166,000,000  on  July 
25,  1917). 31 

As  already  indicated,  a  number  of  banks  located  in  Eng- 
land and  Wales  have  the  right  to  issue  circulating  notes, 
but  the  total  of  their  issues  is  at  present  subject  to  an 
absolute  maximum  limit  of  £1,166,000.  These  notes  have 
no  legal  tender  power  and  have  in  fact  only  local  currency. 
Since  1844  the  uncovered  issue  of  the  Bank  of  England 
has  grown,  by  reason  of  the  lapse  of  country  issues,  from 
£14,000,000  to  £18,450,000.     Several  banks  in  Scotland  and 

bank   has   long  since  ceased   to  avail   itself  of  this   privilege.      (See 
answers  to  questions  addressed  to  the  Governor  and  Directors  of  the 
Bank  of  England,  "Interviews,"  etc.,  already  cited,  p.  12.) 
3i  London  Economist,  July  28,  1917,  p.  137. 


FOREIGN  MONEY  MARKET  FACTORS 


235 


several  in  Ireland  issue  notes  with  local  circulation  and  no 
legal  tender  power. 

The  Bank  of  England  that  presides  over  the  London 
money  market — the  "Old  Lady  of  Threadneedle  Street" — 
is  the  banking  department  of  this  institution.  It  is  this 
department  which  has  as  deposits  the  reserves  of  the  joint 
stock  banks  and  which  from  time  to  time  raises  its  dis- 
count rate  to  check  over-expansion  and  to  "correct"  the 
exchange.32  Beneath  is  a  specimen  statement  of  the  Bank 
of  England,  showing  its  condition  as  it  was  shortly  before 
the  outbreak  of  the  war. 

STATEMENT  OF  THE  BANKING  DEPARTMENT  OF  THE 
BANK  OF  ENGLAND  33 


(June  24,  1914) 


Liabilities 
Proprietors'   capital.  .£14,553,000 

Rest    3,160,254 

Public  deposits   18,074,214 

Other  deposits 44,915,911 

Seven  day  bills,  etc..  .  12,948 


£80,716,327 


Assets 
Government        securi- 
ties    £11,046,570 

Other  securities 39,994,619 

Notes   28,050,150 

Gold  and  silver  coin.      1,624,988 


£80,716,327 


32  Compare  §  144  below. 

33  From  the  London  Economist,  June  27,  1914,  p.  1571.  On  July 
25,  1917,  the  issue  department  had  notes  outstanding  in  the  sum  of 
£68,962,690  and  held  £50,512,690  of  gold.  The  banking  department's 
assets  and  liabilities  were   in  the  following  expanded  condition: 


Proprietors'   capital. £  14,553,000 

Rest   3,311,696 

Public  deposits    ....      46,614,733 

Other    deposits    126,839,973 

Seven   day  bills,  etc.  16,076 


Government      securi- 
ties      £  48,127,661 

Other   securities    ...    111,365,542 

Notes  29,226,320 

Gold  and   silver  coin       2,615,955 


£191 .335,478 
From  Economist,  July   28,    1917,  p.   137. 


£191,335,478 


236  FOREIGN  EXCHANGE 

Statement  of  the  Issue  Department  (same  date) 

Notes   issued    £56,753,275     Government  debt  ....£11,015,100 

Other  securities 34.  .  .      7,434,900 
Gold  coin  and  bullion  38,303,275 


£56,753,275  £56,753,275 

The  banking  department  is  essentially  a  great  commercial 
bank  which  receives  demand  deposits  and  makes  short  term 
loans  or  advances.  It  is  distinguished  by  being  the  bank  of 
the  British  government.  It  is  not  that  the  government  owns 
or  operates  the  bank,  but  merely  that  it  deposits  most  of  its 
funds  with  it,  producing  the  ''public  deposits"  of  the  fore- 
going statement.  The  item  "Government  securities"  shows 
the  amount  of  debt  of  the  British  government,  whether  of 
short  or  long  term,  carried  as  an  asset  by  the  banking  de- 
partment. The  item  "Other  deposits"  includes  deposits  of 
every  description  other  than  those  of  the  government,  de- 
posits of  joint  stock  banks,  discount  houses,  bill  brokers, 
and  private  firms  generally.  The  item  in  the  column  of 
assets,  "Other  securities,"  is  the  cryptic  entry  which  shows 
the  total  of  loans  and  advances  made  in  any  form  to  all 
other  parties  than  the  government.  No  detail  of  this  very 
important  account  is  made  public.  Notes  and  coin  together 
constitute  the  banking  department's  cash  reserve.35 

3*  "Other  securities"  here  signifies  "Parliamentary  securities  like 
the  Government  debt."  Palgrave,  "Bank  Rate  and  the  Money  Mar- 
ket," p.  27. 

33  The  following  is  a  recent  statement  of  the  Bank  of  England, 
taken  from  the  London  Economist  for  May  17th,  1919,  p.  939: 

BANK  OF  ENGLAND 

Week  ended  Wednesday,  May   14,   1919 

Issue  Department 

Notes   issued    £102,463,240      Government  debt  ...£  11,015,100 

Other  securities 7,434,900 

Gold  coin  and  bullion     84,013,240 


£102,463,240  £102,463,240 


FOREIGN  MONEY  MARKET  FACTORS  237 

§  58.  The  Bank  Rate.— The  bank  rate  S6  is  a  rate  of  dis- 
count, determined  upon  and  made  public  by  the  directors 
of  the  Bank  of  England,  as  one  at  which  the  banking  de- 
partment stands  ready  to  discount  or  purchase  certain 
classes  of  bills.  While  this  is  perhaps  the  most  widely 
reported  and  carefully  scrutinized  money  rate  in  the  world, 
its  relationship  with  the  rates  at  which  actual  business  in 
bills  is  transacted  in  England  is  not  a  perfectly  simple 
subject.  Even  the  utterances  of  English  bankers  ou  this 
question  are  often  enigmatical.  Thus  among  the  queries 
put  to  a  number  of  these  gentlemen  in  the  year  1909  by  a 
committee  acting  on  behalf  of  the  United  States  Monetary 
Commission,  was  this  one :  "To  what  extent  does  the  bank 
rate  govern  your  discount  and  loan  transactions?"  Mr. 
Charles  Gow,  General  Manager  of  the  London  Joint  Stock 
Bank,  replied,  ' '  To  speak  in  general  terms,  all  the  business 
we  do  has  a  certain  relation  to  the  Bank  of  England  rate. ' ' 37 
The  answer  of  Lord  Avebury,  at  the  time  president  of  the 
Central  Association  of  English  Bankers,  was  no  more  defi- 
nite than  "The  bank  rate  is  generally  an  expression  of 
the  market  rate. ' ' 38     The  question  was  also  asked  of  the 

Banking  Department 

Proprietors'   capital. £  14,553,000  Government      securi- 

Rest   3,105,747  ties   £  46,433,817 

Public  deposits  *.. .      22,807,099      Other  securities 77,984,317 

Other  deposits 111,479,248      Notes   25,97(5,155 

Seven-day  and  other  Gold  and  silver  coin.        1,560,392 

bills    9,587 

£151,954,681  £151,954,68] 

*  Including  Exchequer,  Savings  Banks,  Commissioners  of  National 
Debt  and  Dividend  Accounts. 

30  Known  more  formally  as  "The  Official  Minimum  Discount  Rate 
of  the  Bank  of   England." 

37  "Interviews,"  etc.,  already  cited,  p.  82. 

38  Ibid.,  p.   120. 


238  FOREIGN  EXCHANGE 

Governor  and  Directors  of  the  Bank  of  England  itself,  and 
lure  pertained  to  this  bank's  own  practice.  The  reply 
brought  forth  was  a  bit  Delphic,  running  to  the  effect  that 
"the  rates  for  discount  and  loan  transactions  at  the  bank 
usually  approximate  more  or  less  closely  to  the  bank 
rate"  39 

In  discussing  the  bank  rate  we  easily  fall  into  the  way 
of  speaking  of  its  relation  to  "the"  market  rate,  as  if  to 
imply  there  is  a  single  rate  for  money  in  the  London  mar- 
ket. In  fact  there  are  always  numerous  distinct  discount 
and  interest  rates  in  force  in  any  money  center.  Their 
differences  depend  primarily  on  term  of  advance  and  char- 
acter of  security.  In  London  a  few  of  these  rates  are  cus- 
tomarily set  with  reference  to  the  bank  rate,  or  are  based 
upon  it,  such  as  the  deposit  allowance  rates,  the  rebate 
rate,  and  the  rate  applied  to  many  trade  bills,40  and  these 
are  therefore  like  the  bank  rate  fairly  stable.41  Others 
are  less  intimately  associated  with  the  bank  rate  and  fluctu- 
ate freely,  sometimes  showing  daily  variations.  These  free 
market  rates  however  rise  and  fall  very  much  as  a  group. 
It  is  true  the  spacings  or  spreads  between  the  different 
individual  rates  may  alter  to  a  degree,  but  they  move  as 
a  body  or  somewhat  as  a  constellation.  Now  when  one 
speaks  of  the  relation  of  the  bank  rate  to  the  market  rate 
he  really  has  in  mind  the  entire  group  of  variable  market 

so  Ibid.,  p.  23. 

4°  "Although  we  say  that  bills  in  the  market  are  discounted  at 
a  lower  rate  than  bank  rate,  yet  there  is  a  vast  number  of  trade 
bills  which  are  purely  governed  by  the  bank  rate."  Statement  of 
Sir  Felix  Schuster,  Governor  of  the  Union  of  London  and  Smith's 
Bank,  in  "Interviews,"  etc.,  already  cited,  p.  53. 

4i  The  bank  rate  may  remain  unaltered  through  a  period  of  per- 
haps six  months.  Again  it  may  be  changed  several  times  a  month 
under  unsettled  conditions.  An  exhaustive  statistical  and  historical 
studv  of  the  bank  rate  is  found  in  R.  H.  Inglis  Palgrave's  "Bank 
Rate  and  the  Money  Market"  (1903). 


FOREIGN  MONEY  MARKET  FACTORS  239 

rates  rather  than  any  single  one  of  them.  If  the  term 
4 'market  rate"  is  used  in  a  single  and  specific  sense,  it  will 
usually  mean  the  rate  of  discount  charged  by  the  bill 
brokers  (and  by  the  banks  to  customers  of  theirs  other 
than  the  bill  brokers)  on  prime  bankers'  acceptances  with 
ninety  days  to  run,  though  sometimes  it  refers  to  the  rate 
on  the  same  paper  with  sixty  days  to  run. 

To  make  the  significance  of  the  bank  rate  really  clear  we 
must  distinguish  between  conditions  of  ease  and  conditions 
of  stringency  in  the  London  money  market.  In  times  of 
ease  the  bank  rate  is  rather  a  nominal  figure.  In  these 
times  it  derives  such  importance  as  it  has  from  being  an 
index  of  the  market.  And  it  is  this  for  the  simple  reason 
that  in  these  times  the  governing  body  of  the  bank  makes  it 
a  practice  to  set  the  rate  at  some  fairly  even  figure  not 
far  above  the  market  rates  for  prime  bills.  Thus  if  the 
latter  were  at  say  3!6  and  3M%,  the  bank  rate  would 
probably  be  standing  at  3M%,  unless  perchance  it 
had  been  placed  at  4%  in  anticipation  of  a  rise  in 
the  market  rates  in  the  near  future.  Under  conditions 
of  monetary  ease  the  bank  rate  is  symptomatic  of  the  market 
and  is  governed  by  it.  Lord  Avebury  evidently  referred 
to  this  fact  in  his  statement  quoted  above  that  "the  bank 
rate  is  generally  an  expression  of  the  market  rate."  In 
periods  of  stringency  the  bank  rate  assumes  a  higher  degree 
of  importance.     As  the  saying  goes,  it  becomes  "effective." 

The  Bank  Rate  in  Times  of  Monetary  Ease 

One  of  the  important  activities  of  the  Bank  of  England 
is  the  discount  of  bills  of  exchange.  But  this  business 
breaks  into  two  distinct  linos,  namely,  (1)  discount  for  the 
bank's  own  regular  mercantile  customers,  and  (2)  discount 
(i.e.,  rediscount)  on  occasion  for  the  bill  brokers  and  cer- 
tain types  of  banking  houses  which  do  not   come  to  the 


240  FOREIGN  EXCHANGE 

Hank  of  England  when  loanable  funds  are  abundant.  The 
first  might  be  called  the  bank's  private  and  regular,  the 
second  its  emergency  discount  business.  The  activities  of 
the  institution  in  its  private  discount  business  are  com- 
parable to  those  of  the  ordinary  joint  stock  banks  in  the 
same  line,  and  to  the  extent  of  these  activities  the  Bank 
of  England  is  competitive  with  the  joint  stock  banks.  In 
this  business  the  Bank  of  England  does  not  observe  its 
own  official  minimum  discount  rate  when  this  rate  is  above 
the  market,  but  without  hesitation  discounts  bills  for  its 
own  customers  at  the  rates  prevailing  in  money  dealings 
generally.  (Compare,  however,  what  appears  in  the  next 
section  regarding  the  bank's  holding  its  discounting  power 
in  reserve  for  times  of  stringency.)  In  times  of  ease  the 
bank  itself  does  not  observe  its  own  official  rate,  and  in 
fact  no  business  in  prime  bills  is  anywhere  being  done  at 
this  rate. 

Authoritative  statements  respecting  the  policy  of  the 
Bank  of  England  are  few  and  far  between,  and  therefore 
the  following  excerpts  from  the  "Interviews  on  Banking 
and  Currency  Systems"  published  by  the  United  States 
National  Monetary  Commission  are  of  especial  interest. 
Examination  of  the  interviews  for  England  (pp.  7-124) 
will  confirm  the  explanations  of  the  London  money  market 
being  given  here.  Under  the  title  of  "Report  of  answers 
to  questions  addressed  to  the  Governor  and  Directors  of 
the  Bank  of  England,"  we  find  these  questions  and  answers 
among  many  others. 

Q.  Will  you  state  (a)  the  class  of  bills  usually  discounted  by 
you,  giving  the  number  of  names  required;  (b)  the  minimum  size; 
and  (c)  the  maximum  length  of  time  to  run? 

A.  (a)  Two  British  names,  of  which  one  must  be  the  acceptor; 
(b)  no  minimum;  (c)  four  months,  exceptionally  six. 


FOREIGN  MONEY  MARKET  FACTORS  241 

Q.  "What  are  the  rules  governing  purchase  by  you  of  foreign 
bills? 

A.  The  bank  does  not  buy  foreign  bills. 

****** 

Q.  What  is  the  distinction  between  what  are  known  as  "prime" 
bills  and  other  bills"? 

A.  A  "prime"  bill  we  should  define  as  a  bill  accepted  by  a  Lon- 
don or  provincial  bank  in  first-class  credit  or  a  merchant  or  mer- 
chant banker  of  the  first  class  whose  business  is  to  grant  credits.42 

The  "merchant  or  merchant  banker  whose  business  it  is 
to  grant  credits"  is  what  we  have  heretofore  spoken  of  as 
the  acceptance  house.  When  the  answer  states  that  the 
bank  does  not  buy  foreign  bills,  the  meaning  is  it  does  not 
take  bills  payable  in  countries  foreign  to  England,  and 
not  that  it  will  not  take  bills  payable  in  England  in  sterling 
but  of  foreign  origin.  A  bill  drawn  by  an  American  mer- 
chant on  a  London  acceptance  house,  accepted  by  the 
latter  and  indorsed  say  by  a  bill  broker,  would  be  a  foreign 
bill  in  the  sense  that  it  is  an  exemplar  of  foreign  exchange 
when  viewed  from  the  standpoint  of  the  world  at  large. 
When  in  England  this  bill  is  in  the  country  where  it  is 
payable,  though  it  is  of  foreign  origin.  The  Bank  of  Eng- 
land would  take  such  a  bill  as  having  two  British  names, 
including  a  British  acceptor. 

Q.  Do  you  discount  any  but  prime  bills? 
A.  Yes. 

****** 

Q.  Do  you  discount  to  any  considerable  amount  for  individuals 
and  merchants? 

A.  The  bank  discounts  all  approved  bills  offered  to  it  by  per- 
sons or  firms  having  properly  constituted  accounts  [i.e.,  deposits 
in  the  American  sense]. 


'-  See  "Interviews,"  pp.  20  and  22. 


242  FOREIGN  EXCHANGE 

Q.  Do  you  rediscount  bills  for  the  joint  stock  or  other  banks? 

A.  The  bank  is  always  prepared  to  rediscount  for  other  banks 
at  its  official  rate,  and  docs  a  large  business  from  time  to  time 
with  the  colonial  and  foreign  exchange-banks  [foreign  banks  with 
London  branches  or  correspondents]  who  are  from  the  nature  of 
their  business  always  sellers  of  bills.  The  London  Clearing  and 
\V<  -t  End  banks  [the  greater  indigenous  banks]  who  are  ordi- 
narily buyers  of  bills  and  not  sellers  do  practically  no  discount 
business  with  the  bank. 

The  greater  London  banks  nevertheless  manage  on  occasion 
to  shift  a  heavy  discounting  burden  onto  the  shoulders  of 
the  Bank  of  England.  How  this  is  accomplished  will  be 
related  in  the  next  section. 

Q.  Do  you  sometimes  purchase  "prime  bills"  in  the  market  at 
a  lower  rate  than  bank  rate? 

A.  The  bank  does  not  purchase  bills  in  the  market. 

This  means  only  that  the  bank  does  not  buy  bills  from 
sellers  generally  but  deals  alone  with  persons  or  institu- 
tions having  deposits  with  it.  The  statement  is  misleading 
to  the  uninitiated  because  it  suggests  that  the  bank  does 
not  discount  bills  that  have  been  in  the  market,  whereas 
at  times  it  does  a  great  business  of  this  kind  by  redis- 
counting  for  brokers  and  bankers  having  accounts  with  it. 

Q.  Would  you  charge  a  merchant  house  having  a  good  account 
with  you,  the  bank  rate  or  the  market  rate  for  prime  bills? 
A.  The  market  rate.43 

The  following  is  from  the  statement  of  Mr.  Charles  Gow, 
of  the  London  Joint  Stock  Bank.44 

Q.  Do  you  regard  the  Bank  of  England  as  in  any  way  a  com- 
petitor of  yours? 

43  "Interviews,"  etc.,   pp.   20-23,   contains  the  preceding  questions 
and  answers. 
4*  Hid.,  p.  86. 


FOREIGN  MONEY  MARKET  FACTORS  243 

A.  Yes;  the  Bank  of  England  has  a  department  in  which  it  has 
customers  just  exactly  as  we  have  keeping  current  accounts  [i.e., 
commercial  deposits,  American  usage]. 

War  time  note. — Early  in  the  year  1917,  the  Bank  of 
England  so  far  systematized  its  formerly  occasional  prac- 
tice of  borrowing  funds  in  the  open  market,  as  to  name 
a  regular  rate  of  interest  which  it  stood  ready  to  pay 
any  London  clearing  bank  for  short  term  loans  to  be  made 
by  such  bank  to  the  Bank  of  England.  The  purpose  of  the 
Bank  of  England  here  is  the  regulation  of  rates  in  the 
open  market.  In  June  the  London  Economist  began  the 
publication  of  the  new  rate  in  its  regular  weekly  tables 
under  the  title  of  "Bank  of  England  Rate  to  Clearing 
Banks."  It  would  appear  that  it  is  quoted  for  loans  at 
three  days,45  though  loans  for  other  periods  may  also  be 
arranged. 

This  gives  us  a  second  and  distinct  bank  rate,  the  signifi- 
cance of  which  to  the  open  market  is  in  general  greater 
than  that  of  the  original  or  official  bank  rate  itself.  The 
effect  of  the  offer  by  the  Bank  of  England  of  say  5%  for 
three-day  loans  is  to  make  it  impossible  for  any  one  to 
obtain  call  or  short  term  money  from  the  great  London 
banks,  and  consecpiently  from  any  others,  at  a  cheaper 
figure.  This  will  cause  the  rates  of  discount  for  bills  to  be 
sustained  at  some  figure  above  5%.  Why  the  central  insti- 
tution has  an  interest  at  certain  times  in  stiffening  the  open 
market,  even  perhaps  at  some  expense  to  itself,  will  be  dis- 
cussed later. 

The  establishment  of  relations  between  the  Bank  of  Eng- 
land and  the  U.  S.  Federal  Reserve  System. — On  December 
20,  1916,  the  Federal  Reserve  Board  approved  the  applica- 
tion of  the  Federal  Reserve  Bank  of  New  York  For  the 
establishment  of  certain  relations  between  it  and  the  Bank 

45  Economist  for  June  23,  l!H7,  p.  1145. 


•J  14  FOREIGN  EXCHANGE 

of  England.  The  following  statement  regarding  the  char- 
acter  of  these  relations  is  taken  from  a  "communication" 
received  by  the  London  Economist  and  published  in  its 
issue  of  -May  5,  1917,  page  766.  "Negotiations  for  estab- 
lishing relations  between  the  Bank  of  England  and  the 
Federal  Reserve  Bank  of  New  York,  which  were  com- 
•menced  by  the  governors  of  the  respective  institutions  some 
months  ago,  have  now  been  concluded.  The  arrangement 
provides  that  the  Bank  of  England  will  act  as  the  corre- 
spondent and  agent  in  London  of  the  Federal  Reserve  Bank 
of  New  York,  and  that  the  Federal  Reserve  Bank  of  New 
York  will  act  in  a  similar  capacity  in  New  York  for  the 
Bank  of  England.  It  is  not  the  intent  of  the  plan  that 
these  institutions  engage  in  commercial  foreign  transactions, 
the  relationship  established  being  primarily  for  the  purpose 
of  affording  greater  stability  to  rates  of  exchange  by  main- 
taining with  each  other  mutual  accounts  of  deposit,  and 
by  representing  each  other  in  the  purchase  of  bills.  The 
plan  will  also  create  machinery  by  which  transactions  in 
gold  and  gold  coin  will  be  facilitated,  which  should  result 
in  normal  times,  in  eliminating  or  reducing  the  extensive 
and  unnecessary  shipments  of  gold  between  nations  to  settle 
international  balances,  which  have  heretofore  not  infre- 
quently prevailed." 

§  59.  Rediscounting  at  the  bank  in  times  of  stringency. — 
The  fact  that  the  Bank  of  England  is  to  a  degree  a  com- 
petitor of  the  joint  stock  banks  appears  to  be  a  cause  of 
complaint  on  the  part  of  the  latter,46  for  the  bank  has  very 
large  deposits  from  these  institutions  interest-free,  and  thus 
may  be  charged  with  using  their  funds  to  accommodate  busi- 
ness which  might  otherwise  come  to  them.  On  the  other 
hand  the  Bank  of  England  has  its  own  earnings  to  look 

46  The  fact  that  the  Bank  of  England  is  a  competitor  is  a  "source 
of  grave  complaint  by  the  other  .banks."  Statement  of  Sir  Felix 
Schuster,  "Interviews,"  etc.,  p.  48. 


FOREIGN  MONEY  MARKET  FACTORS  245 

after  in  the  long  periods  of  monetary  ease  and  quiet.  But 
the  merits  of  this  question  lie  beyond  our  field.  The  great 
and  outstanding  fact  is  that  the  bank  does  not  enter  into 
full  and  unreserved  competition  with  the  other  institutions 
of  the  open  market.  "Without  its  making  any  express  ac- 
knowledgments that  it  is  under  any  peculiar  obligations,  the 
Bank  of  England  in  point  of  practice  keeps  its  own  private 
discount  business  within  limits  and  contrives  to  hold  its 
discounting  power  in  reserve  in  order  to  take  care  of  the 
general  money  market  of  London  in  times  of  striugency. 
It  is  the  custom  of  the  bank  to  follow  this  polic}r  and 
London  expects  it  to  do  so,  although  there  is  no  legislation 
directly  or  indirectly  making  the  policy  compulsory.  This 
is  the  British  way. 

The  method  by  which  the  city  secures  relief  from  the 
bank  under  conditions  of  strain  is  simply  that  of  redis- 
count, and  it  is  for  this  reason  that  the  Bank  of  England 
belongs  to  the  class  known  as  banks  of  rediscount.  But, 
as  already  made  clear,  some  of  the  great  joint  stock  banks 
never  rediscount  with  the  Old  Lady  of  Threadneedle  Street 
or  at  any  other  place.  What  the  policy  of  all  these  insti- 
tutions is,  is  not  publicly  known,  but  it  seems  to  be  generally 
assumed  in  the  literature  of  the  subject  that  there  is  no 
appreciable  rediscounting  by  this  group  under  any  condi- 
tions.47 But  even  if  these  banks  do  not  make  direct  appli- 
cation to  the  Bank  of  England  for  aid  in  time  of  trial,  they 
have  a  way  nevertheless  of  passing  much  of  the  burden  of 
the  moment  over  to  this  establishment.48     The  proceedings 

*~  In  this  respect  English  banking  practice  is  in  sharp  contrasl 
with  that  in  France  and  Germany  and  other  continental  countries, 
where  even  the  greatest  ordinary  incorporated  hanks  rediscount 
freely  with  their  respective  central   hanks. 

48  For  the  student  it  may  he  explained  that  the  burden  in  <|iies- 
tion  is  that  of  exchanging  cash  for  time  paper.  A  period  of  strain 
is  one  in  which  demands  for  cash  on  the  part  of  the  depositors  "i 
creditors  of  the  banks  are  too  heavy  for  satisfaction   from  the  exist- 


246  FOREIGN  EXCHANGE 

which  take  place  are  peculiar  to  London  and  are  essentially 

is  follows.  Tlic  joint  stock  banks  find  their  reserves  be- 
eoming  too  low.  Thereupon  they  fall  back  upon  one  of 
their  most  liquid  assets,  the  one  listed  in  their  balance  sheets 
next  to  their  "cash  in  hand  and  at  the  Bank,"  namely,  the 
call  and  short  term  loans  which  they  have  made  to  the 
bill  brokers  and  discount  houses.  They  exercise  their  privi- 
lege of  terminating,  or  calling,  these  loans  and  this  imposes 
upon  the  bill  dealers  the  necessity  of  paying  them  off  in 
cash.  But  the  bill  dealers  have  invested  all  this  call  and 
short  term  money  in  bills,  and  to  return  it  to  the  banks 
they  must  sell  all  or  most  of  their  bills.  Usually  they  sell 
bills  to  the  banks  themselves,  but  not  now,  because  now 
the  banks  are  not  buying  bills,  at  least  in  the  usual  quan- 
tities, being  engaged  in  converting  assets  into  cash  rather 
than  converting  cash  into  bills  or  any  other  kind  of  paper 
assets.  The  Bank  of  England  now  stands  as  a  place  of 
refuge  for  the  bill  dealers.  If  the  stringency  is  severe  a 
veritable  rush  into  the  bank  may  ensue.  As  they  say  in 
London,  "the  market  has  come  to  the  Bank"  or  "the  bill 
brokers  are  in  the  Bank."  On  these  occasions  the  cen- 
tral institution  undertakes  to  provide  accommodation,  but 
charges  the  official  bank  rate,  meanwhile,  in  case  of  need 
elevating  this  rate. 

The  immediate  results  of  this  process  are  two:  an  in- 
crease in  the  reserves  of  the  joint  stock  banks  and  a  de- 
crease in  the  reserve  of  the  Bank  of  England.     The  first 

ing  reserves  without  embarrassment.  So  it  becomes  necessary  to 
convert  some  of  the  assets  other  than  cash  into  cash.  For  this  pur- 
pose the  joint  stock  banks  might  sell,  or  rediscount,  bills  from  their 
portfolios,  but  this  is  what  they  do  not  do  in  practice.  Instead 
they  convert  their  call  loans  to  bill  brokers,  another  asset,  into  cash. 
They  do  this  indirectly  by  the  aid  of  the  Bank  of  England,  and  it  is 
practically  all  one  to  that  institution  which  way  they  follow,  though 
it  appears  not  to  be  all  one  from  the  standpoint  of  the  joint  stock 
banks. 


FOREIGN  MONEY  MARKET  FACTORS  247 

result  comes  about  practically  in  this  manner.  The  bill 
brokers  use  the  proceeds  of  their  rediscounts  and  loans  49 
at  the  Bank  of  England  to  pay  off  their  call  loans  at  the 
joint  stock  banks.  They  draw  checks  on  the  Bank  of  Eng- 
land in  favor  of  these  banks  and  the  latter  simply  deposit 
the  checks  to  the  credit  of  their  own  accounts  with  the 
same  institution.  This  augments  their  reserves  by  increas- 
ing that  part  of  reserves  known  as  "cash  at  the  Bank  of 
England."  That  these  additional  deposits,  like  all  the  de- 
posits at  the  Bank  of  England,  are  subject  to  withdrawal 
in  cash  on  demand,  goes  without  saying.  To  what  extent 
the  Bank  of  England  will  begin  to  lose  cash  depends  on 
circumstances,  but  more  upon  the  international  gold  move- 
ment than  upon  domestic  conditions.  If  gold  exports  are 
taking  place  from  London,  the  Bank  of  England  is  likely 
to  have  to  supply  a  large  part  of  the  metal.  That  is,  some 
one  exporting  gold  will  turn  up  at  the  bank  with  checks 
payable  by  it  and  demand  actual  specie,  or  will  demand  it 
on  account  of  his  own  deposit  credit. 

The  decrease  in  the  reserve  of  the  Bank  of  England 
ensues  whether  or  not  the  joint  stock  banks  make  cash 
withdrawals  from  their  deposits,  though  the  effect  on  the 
reserve  is  much  greater  if  they  do  make  such  withdrawals. 
We  have  here  to  recall  explanations  first  made  in  §§19 
and  20.  If  no  withdrawals  of  deposits  are  made,  the 
percentage  of  the  reserve  of  the  bank  is  reduced  because; 
its  deposit  liabilities  have  been  expanded  without  its  having 
received  any  inpayments  of  cash.  Total  demand  liabilities 
having  increased  and  total  cash  having,  as  we  assume,  stood 
still,  the  cash  bears  a  smaller  proportion  to  the  liabilities 
than  before.  This  decline  in  the  percentage  of  the  reserve 
is  properly  spoken  of  as  a  decrease  in  the  reserve,  even 
when  there  has  been  no  absolute   falling  off  of  the   cash 

49  In  addition  to  the  rediscount  of  hills  at  the  bank,  the  market 
(namely,  the  bill  dealers)   may  procure  some  loans  on  collateral. 


FOREIGN  EXCHANGE 

on  hand,  because  it  is  the  proportion  of  the  reserve  to  the 
rve-bearing  liabilities,  and  not  in  the  least  the  absolute 
amount  of  cash  in  vault,  which  determines  the  strength  of 
a  bank's  position. 

If  cash  withdrawals  are  made,  the  absolute  amount  of  the 
cash  on  hand  is  reduced,  and  the  percentage  of  the  reserve 
is  reduced  in  greater  degree  than  under  the  first  supposi- 
tion.50 The  Bank  of  England's  discounting  and  lending 
power  is  hardly  unlimited.  When  as  a  consequence  of  its 
aiding  the  market  it  finds  its  reserve  beginning  to  decline, 
it  must  take  steps  to  prevent  this  process  from  going  too 
far  for  the  reasons  which  govern  any  bank.  Although  it  is 
fortified  by  the  tremendous  traditional  public  confidence 
imposed  in  it,  it  must  not  allow  its  reserve  to  fall  to  the 
point  which  might  be  provocative  of  a  run.  The  chief 
preventive  it  applies  in  these  junctures  is  an  elevation  of  the 
bank  rate.  The  highest  point  this  rate  has  ever  reached  is 
10%.  In  the  period  from  1844  to  1900  inclusive,  compris- 
ing 20,570  days,  it  stood  at  6%  for  a  total  of  868  days,  at 
7%  for  577  days,  at  8%  for  268  days,  at  9%  for  95  days, 
and  at  10%  for  141  days.51  On  the  first  four  days  of 
August  1914  it  was  at  10%.  Since  1844  the  rate  has  been 
at  this,  its  extreme  height,  in  but  three  years,  1857,  1866, 
and  1914. 

When  the  bank  rate  is  elevated  as  a  protective  measure, 
an  effect  is  produced  upon  both  the  domestic  and  the  for- 
eign influences  impinging  on  the  London  money  market,  but 
the  effect  on  the  foreign  influences  is  the  more  important. 
It  is  true  an  increase  in  the  charge  for  discounts  and  ad- 
vances tends  to  repress  the  demand  for  accommodation 
which  comes  from  purely  domestic  sources,  or  tends  to  re- 
duce the  proportion  which  the  volume  of  paper  seeking 
discount  bears  to  the  funds  available  for  taking  care  of  it, 

so  Compare  calculations  in  §  20. 

si  From  Palgrave's  "Bank  Rate  and  the  Money  Market,"  p.  99. 


FOREIGN  MONEY  MARKET  FACTORS  249 

and  thus  tends  to  provide  relief  from  the  drain.  But  for 
London,  as  contrasted  with  any  other  center,  the  domestic 
effects  of  increased  rates  for  money  have  the  smallest  im- 
portance relative  to  what  we  may  call  the  foreign  effects, 
namely  the  effects  upon  dealings  in  other  countries  in  ster- 
ling exchange  and  upon  the  international  gold  movement. 
The  latter  will  be  brought  under  discussion  in  Chapter  XX 
below,  after  the  ground  has  been  further  prepared  for  the 
subject.  During  periods  of  stress  the  bank  discounts  for 
and  makes  loans  to  the  London  market  and  protects  itself 
when  necessary  by  increasing  its  rate.  At  such  times  this 
rate  is  an  effective  one,  governing  actual  business.  When 
the  monetary  pressure  subsides  and  ordinary  conditions 
return  the  bank  rate  resumes  its  nominal  character  and 
becomes  a  mere  index  of  the  market. 

War  time  note. — Certain  modifications  in  the  practice 
of  the  London  money  market  have  been  produced  by  the 
conditions  of  war.  Probably  various  minor  changes  are 
now  in  effect  that  cannot  be  ascertained,  much  less  clearly 
understood,  by  any  one  outside  the  immediate  circle  of 
bankers  and  dealers  directly  concerned.  It  is  too  early 
to  undertake  prophecy  as  to  what  alterations  if  any  will 
be  perpetuated  after  the  war,  though  it  seems  unlikely  thai 
the  general  framework  will  be  modified  seriously.  We  have 
already  adverted  to  the  new  bank  rate,  or  rate  of  interest 
offered  by  the  Bank  of  England  to  the  clearing  banks  for 
short  term  loans.  It  remains  to  speak  of  a  new  practice 
in  borrowing  from  the  Bank  of  England,  as  evidenced  by 
the  following  news  item,  dated  March  3d,  1917.  "Money 
has  been  comfortably  abundant,  on  the  whole,  though  a 
little  business  in  discounts  at  51/4%  has  been  done  at  the 
Bank  of  England.  It  is  clear  that  the  banks  are  acting 
mercifully  by  the  bill  brokers,  and,  instead  of  calling  in 
money  from  them,  arc  going  direct  to  the  Bank  of  England 


250  FOREIGN  EXCHANGE 

themselves,  and  borrowing  the  sums  needed  in  order  to 
carry  oul  the  big  transfers  of  cash  involved  in  the  War 
Loan  payment."  It  is  stated  only  that  the  "banks"  are 
acting  mercifully  by  the  bill  brokers,  but  it  may  be  as- 
sumed that  the  great  joint  stock  banks,  or  some  of  them, 
are  meant.  The  loans  referred  to  are  incidental  to  very 
special  and  large  operations  connected  with  the  govern- 
ment 's  borrowings  and  are  doubtless  undertaken  for  the 
laudable  purpose  of  reducing  the  accompanying  money 
market  disturbances,  and  one  cannot  infer  that  they  will 
hold  their  place  in  practice  after  the  war.  Nevertheless 
it  appears  there  has  been  here  at  least  some  departure  from 
the  ante-bellum  methods,  under  which  the  great  banks 
customarily  refrained  in  periods  of  stress  from  applying 
for  advances  from  the  Bank  of  England,  and  resorted  ex- 
clusively to  the  expedient  of  calling  in  their  day  to  day 
and  short  loans  thus  forcing  the  bill  dealers  into  the  bank. 

§  60.  Interest  and  discount  rates  customarily  in  fixed 
relation  with  the  bank  rate. — Five  rates  appearing  in  Lon- 
don banking  and  bill  dealing  are  as  a  matter  of  custom 
based  directly  upon  the  bank  rate,  standing  in  ordinary 
times  at  a  fixed  or  specified  distance  above  or  below  this 
rate  or  exactly  even  with  it.  As  the  bank  rate  steps  up  or 
down,  these  rates  step  up  or  down  to  the  same  extent. 
Three  are  interest,  and  two  are  discount  rates. 

(1)  The  regular  deposit  allowance  rate. — This  is  the 
rate  of  interest  paid  by  the  joint  stock  banks  on  the  de- 
posits at  notice  of  ordinary  persons  or  firms.  It  is  deter- 
mined upon  by  these  banks  in  concert,  at  meetings  of  their 
representatives  held  every  time  the  bank  rate  is  changed,52 
but  the  usual  practice  has  been  to  set  it  at  a  point  VA% 
below  the  bank  rate.  "When,  however,  the  latter  ascends  to 
a  high  figure,  the  deposit  allowance  rate  does  not  neces- 

52  See  statement  of  Sir  Felix  Schuster,  '"Interviews,"  etc.,  p.  45. 


FOREIGN  MONEY  MARKET  FACTORS  251 

sarily  follow  it  up.  For  instance  in  the  panic  year  of 
1907  the  bank  rate  climbed  to  7%  but  the  deposit  allow- 
ance rate  did  not  go  above  4%.  During  the  present  war 
the  relation  of  this  rate  to  the  bank  rate  has  become  very 
much  less  intimate  than  it  was  in  the  preceding  period 
of  peace,  the  spread  between  the  two  showing  great  varia- 
bility. The  discount  houses  have  deposit  allowance  rates 
as  well  as  the  banks.  These  are  not  necessarily  identical 
with  the  banks'  rate  and  are  allowed  on  deposits  on  demand 
as  well  as  deposits  at  notice.  Deposits  at  notice  usually 
bear  a  higher  rate  than  those  on  demand. 

(2)  Rate  allowed  on  the  balances  of  foreign  banks. — 
This  rate,  analogous  to  the  foregoing,  differs  for  different 
banks  and  is  placed  at  a  stipulated  distance  under  the  bank 
rate,  commonly  with  a  maximum  limitation.  It  is  usually 
Vi  to  1%  below  the  bank  rate.53  This  is  a  rate  allowed  by 
the  joint  stock  banks  on  the  checking  accounts  of  foreign 
banks. 

(3)  Rate  of  interest  charged  on  overdrafts. — Lending  by 
the  method  of  overdrafts  is  not  regular  London  practice,54 
but  foreign  banks  arrange  for  overdrafts  on  occasion  on 
their  correspondents  in  London,  and  these  are  usually  sub- 
ject to  an  interest  charge  at  the  Bank  of  England  rate 
or  at  %  to  1%  above  it,  according  to  agreement.05 

(4)  The  retirement  rate  of  discount. — This  rate  (dis- 
cussed in  §  35)  is  in  English  practice  maintained  at  a  figure 
%%  above  the  deposit  allowance  rate,  and  thus  through  the 
latter  is  related  to  the  bank  rate.  When  the  deposit  allow- 
ance rate  is  at  VA%  below  the  bank  rate,  the  retirement 
rate  is  1%  below  it. 

(5)  Rate  of  discount  applied  to  many  trade  bills. — Trade 

gs  Margraff,  "International  Exchange,"  p.   117. 

-'Statement  of  the  manager  of  the  London  Joint  Stock  Bank,  in 
"Interviews,"  etc.,  p.   78. 
55  Margraff,   'International  Exchange,"  p.  117. 


FOREIGN  EXCHANGE 

bills,  or  those  drawn  on  merchants  instead  of  upon  banks, 
are  discounted  at  rates  which  vary  considerably  according 
to  personal  security,  character  of  documents,  and  term, 
hut  large  quantities  of  these  bills  are  as  a  matter  of  in- 
formal practice  discounted  exactly  at  the  bank  rate.56 

Wiih  respect  to  the  general  market  rates  which  do  not 
have  a  fixed  relation  with  the  bank  rate,  such  as  the  open 
market  rate  for  bankers'  acceptances  or  the  rates  for  trade 
bills  accepted  by  the  larger  mercantile  houses,  these  rates 
usually  lie  in  a  region  between  say  %  and  M%  below  the 
bank  rate.  Another  and  on  the  whole  better  way  of  stat- 
ing this  is  that  usually  the  bank  rate  is  placed  a  distance 
above  the  market  rate  on  bankers'  acceptances,  and  is  main- 
tained at  a  fairly  steady  figure  while  market  rates  fluctuate 
freely  by  sixteenths  and  eighths  of  1%.  The  excep- 
tion to  this  occurs  in  times  when  the  bank  rate  becomes 
effective,  as  explained  on  earlier  pages. 

§  61.  The  group  of  London  money  rates. — The  tables  of 
London  money  rates  published  in  the  London  Economist 
are  the  most  complete  among  those  readily  accessible  to 
the  common  man.  Beneath  is  a  specimen  of  the  briefer 
table  appearing  regularly  in  that  journal's  weekly  article 
on  money.57 

Aug.  24,    Aug.  17,    Aug.  10,     Aug.  3, 
1917  1917  1917  1917 

%  %  %  % 

Bank  rate   5  5  5  5 

Bank  of  England  rate  to 

Clearing  Banks 4  4  4  4 

Bank's  deposit  rate 4  4  4  4 

Market   rate    (3    months 

bills)   4%  *%«  4%  i%6  4%  J%6  4%  ^e 

56  See  "Interviews,"  etc.,  pp.  53  and  83. 

57  The  first  table  is  from  the  Economist  for  Aug.  25,  1917,  p.  274. 
The  longer  tables  are  from  the  issue  for  May  5,  1917,  p.  788. 


FOREIGN  MONEY  MARKET  FACTORS 


253 


The  more  detailed  tabulations  to  follow  give  a  better  idea 
of  the  number  of  rates  and  the  extent  to  which  they  vary 
as  between  different  days  and  different  classes  of  discounts 
and  advances. 

LONDON  RATES 


00" 

p. 

0" 

^  i-i 

< 

rH   f 

3 

CO   t~ 

C3    r-l 

08  in 

% 

% 

% 

% 

% 

% 

% 

5 

a 

5 

5 

5 

5 

Market    rates    of    dis- 

count:— 

60      days'      bank- 

ers'  drafts 

4% 

% 

4%      % 

4«/i6 

4%  iVie 

4%  1%6 

«1VS6 

4% 

3    months'    do.... 

4% 

4%  l%6 

4«A6  % 

41V16  y* 

4% 

4% 

4% 

4    months'    do.. .. 

4% 

4%  i-yie 

4% 

4H/16  % 

4% 

4% 

4% 

6   months'    do.... 

iWm  i%o 

4% 

41?i6  % 

4W1B  % 

41%6  % 

4l%e  % 

4%     % 

Loans: — Day   to  day. 

4 

% 

3%    414 

3        4 

3V2    4% 

4V4    4% 

4% 

3%  4^ 

Short    

4% 

u. 

Wi     % 

4%      % 

4%      % 

4%    y2 

4y*    y2 

4V4     % 

Fortnight       (at       last 

5% 

5y2 

5% 

5y2 

5 

5 

5 

Deposit   allowances : 

4 

4 

4 

4 

4 

4 

4 

Discount    houses 

4 

4 

4 

4 

4 

4 

4 

At  notice    

4% 

414 

414 

4y4 

4Vi 

4y4 

414 

Comparison  with  previous  weeks : 


ll 

Trade  Bills 

Rank  Bills 

"2 

0 

2 

.3 

0 

0 

3 

5 
a 
0 

3 

c 
0 

2 

BO 

a 

0 

2 

1 
0 

« 

«* 

«o 

CO 

■** 

ce 

1917 

Vo 

% 

% 

% 

% 

% 

% 

Feb. 

9... 

4%     5 

r, 

rj 

r, 

6% 

5%    % 

5'/2      6 

16... 

5 

5^ 

5% 

BH 

5% 

5%    % 

5%      « 

23... 

5 

5%6 

5-yio     y* 

5y* 

5% 

5%    % 

5%      6 

Mar. 

2... 

4%     5 

5 

5        % 

G 

% 

5% 

5V4    % 

5V4      6 

9... 

4'/2      % 

4%     i-Vic, 

4%        % 

4y4 

1%6 

5y*  % 

5'/2 

r,i,        :r, 

16... 

4*4      % 

4V2      n/i<i 

4y2      % 

4% 

% 

5 

5        % 

5            % 

23... 

4y4     % 

4% 

4>/2 

4y2 

5 

5        % 

5           % 

30... 

4%    y 

4%8 

ma 

4%a 

5 

b     y 

r>        y 

April 

4... 

4%    y2 

4y       °An 

4%a 

5 

5     y 

5        y, 

13... 

4      y 

4% 

4V2          % 

4% 

4% 

5 

5        y 

20... 

4>i    y2 

4i-"K»    % 

m     % 

4% 

5 

5 

5     y 

5        % 

27... 

4%    y2 

4% 

i 

^lO 

5 

B 

b        y 

May 

4... 

41/*      % 

4% 

4% 

4% 

% 

5 

5     y 

y 

254  FOREIGN   EXCHANGE 

The  rate  for  "floating  money"  means  the  rate  for  short 
loans  (s(  e  the  first  column  of  the  last  table).  By  assembling 
all  rales  found  in  the  foregoing  tables  and  adding  a  few 
more,  we  shall  obtain  a  practically  complete  list  of  dis- 
count and  interest  rates  prevailing  in  the  world's  monetary 
capital  at  the  present  time.     The  list  follows: 

(1)  The  Bank  Rate,  or  "Official  Minimum  Discount  Rate  of  the 

Bank  of  England." 

(2)  The  Bank's  rate  to  clearing  banks,  or  rate  of  interest  offered 

the  clearing  banks  by  the  Bank  of  England  for  short  term 
loans  to  be  made  by  them  to  it. 

(3)  The  market  rate,  or  the  rate  of  discount  in  the  open  market 

for  prime  bankers'  acceptances  with  90  days  to  run.  As- 
sociated closely  with  this  is  the  sub-group  of  rates  for 
bankers'  acceptances  with  other  lengths  of  life. 

(4)  The  open  market  rates  for  trade  bills  (those  drawn  on  mer- 

cantile firms,  etc.)  varying  according  to  personal  security 
and  tenor. 

(5)  Interest  rate  on  "day  to  day"  or  call  loans. 

(6)  Interest  rates  on  term   loans,  varying  according  to  term, 

parties,  and  character  of  collateral. 

(7)  Interest  rate  known  as  the  "deposit  allowance  rate,"  paid 

by  joint  stock  banks  for  deposits  at  notice. 

(8)  Deposit  allowance  rates  paid  by  discount  houses  for  deposits 

at  notice  and  also  for  deposits  at  call  (the  latter  being 
generally  a  trifle  lower  than  the  former). 

(9)  Interest  rates  paid  by  banks  on  the  balances  of  foreign 

banks  carried  with  them. 

(10)  Overdraft  rates,  or  rates  of  interest  charged  by  banks  on  the 

overdrafts  of  other  banks  carrying  balances  with  them. 

(11)  The  retirement  rate  of  discount  or  "rebate"  rate. 

(12)  The  arrival  discount  rates  for  divers  types  of  bills  remitted 

by  foreign  banks  (see  next  section). 

Of  the  above  rates,  numbers  3,  4,  9,  11,  and  12,  are  of  the 
most  direct  interest  to  bankers  outside  of  England  in  con- 
nection with  their  dealings  in  sterling  exchange. 


FOREIGN  MONEY  MARKET  FACTORS  255 

§  62.  The  "arrival"  discount  rate. — Sufficient  attention 
has  already  been  paid  to  the  rates  listed  in  the  preceding 
section,  except  the  "arrival"  or  "forward"  discount  rate. 
This  is  a  rate  at  which  a  London  correspondent  bank  will 
undertake  to  discount  a  bill  or  parcel  of  bills  "to  arrive," 
to  use  the  banker's  phrase.  This  means  it  is  a  rate  which 
a  correspondent  quotes,  by  telegraph  to  an  exchange  bank 
dealing  with  it,  in  advance  of  the  shipment  of  a  parcel  of 
bills  by  the  latter.  The  rate  when  accepted  is  applicable 
to  any  bills  mailed  on  the  day  when  the  quotation  is  re- 
ceived. It  will  be  applied  to  these  bills  on  the  day  of  their 
arrival,  from  five  to  fifteen  days  later  according  to  circum- 
stance and  location,  in  the  case  of  bills  shipped  by  Ameri- 
can banks  to  England.  The  arrival  rate  differs  according 
to  time  expected  to  elapse  before  the  bills  are  received  and 
according  to  the  character  of  the  bills — in  other  words  there 
are  really  a  number  of  arrival  rates.  When  the  American 
banker  rates  a  certain  bill  as  belonging  to  a  given  class  and 
as  being  therefore  entitled  to  a  certain  quoted  arrival  rate, 
this  rating  must  of  course  be  confirmed  by  the  London  bank, 
but  the  American  banker  gets  to  be  a  good  prognosticator 
in  this  matter  respecting  such  bills  as  he  sends  over  under 
the  arrival  rates. 

The  quotation  of  such  a  rate  by  a  London  bank  amounts 
to  an  undertaking  to  purchase  long  bills  at  a  designated 
present  worth  in  sterling  on  a  future  date,  namely  the  date 
of  their  receipt.  The  arrival  rate  being  accepl r<l,  the 
London  bank's  obligation  is  not  affected  by  the  actual  mar- 
ket rate  of  the  day  of  the  receipt  of  the  bills.  By  obtain- 
ing and  accepting  arrival  rates,  the  American  bank  avoids 
a  speculation  on  the  changes  that  may  take  place  in  the 
London  money  market  during  the  journey  of  cadi  lot  of 
bills  across  the  Atlantic.  For  without  an  arrival  rale  il 
would  be  taking  its  chances  as  to  what  the  market  rate 
will  be  on  the  day  of  arrival.      The  London  hank  shoulders 


FOREIGN  EXCHANGE 

the  speculation.  Tt  has  superior  opportunities  to  predict 
the  future  course  of  London  rates.  If  its  arrival  quotation 
turns  out  higher  than  the  actual  market  rate  of  the  day 
when  the  lulls  come  in,  it  makes  a  gain,  if  lower  a  loss.  On 
khe  average  it  cannot  make  very  great  gains,  otherwise  the 
American  hank  would  fall  to  taking  its  chances  on  the 
market  rate.  It  is  only  by  reason  of  the  existence  of  the 
arrival  rate  that  the  calculation  of  the  value  of  a  long 
sterling  draft  in  New  York  can  be  made  perfectly  definite 
(compare  §  64).  Continental  banks  in  general  quote  ar- 
rival discount  rates  as  well  as  the  English. 

§  63.  Stamp  taxes. — There  remains  to  be  considered  but 
one  further  factor  which  influences  the  American  dealer 
in  exchange  in  his  price-making  for  bills.  This  is  the 
stamp  tax  on  negotiable  instruments  levied  by  the  govern- 
ment of  the  foreign  country  in  which  the  bills  in  question 
are  payable.  As  previously,  we  shall  restrict  our  dis- 
cussion to  the  case  where  the  foreign  country  is  England, 
but  nearly  all  the  leading  countries  of  the  world,  except 
the  United  States,  impose  stamp  taxes  on  bills  and  notes.58 

The  chief  provisions  of  the  British  law  pertinent  to  deal- 
ings in  exchange  are  as  follows.  Cheques:  Cheques  and 
drafts  payable  on  demand,  or  within  three  days  after  sight, 
pay  a  tax  of  Id.  regardless  of  the  amount  for  which  they 
are  drawn.  Long  tills:  (1)  Long  drafts  drawn  in  the 
United  Kingdom,  and  long  drafts  made  payable  in  the 
United  Kingdom,  though  of  foreign  origin,  are  taxable  ac- 
cording to  the  following  schedule, — 

Not  exceeding    £5 .Id. 

Above  £5  and  not  exceeding    10 2d. 

58  A  very  comprehensive  article  giving  the  stamp  taxes  of  prac- 
tically all  countries  of  the  globe,  as  in  force  at  the  time  of  writing, 
is  to  be  found  in  the  Journal  of  the  Institute  of  Bankers,  London, 
vol.  XXIX,  pp.  427-51.  So  far  the  war  has  worked  no  changes  in 
the  British  stamp  taxes  on  checks  and  drafts. 


FOREIGN  MONEY  MARKET  FACTORS  257 

Above  10  and  not  exceeding    25 3d. 

Above  25  and  not  exceeding    50 6d. 

Above  50  and  not  exceeding    75 9d. 

Above  75  and  not  exceeding  100 Is.  Od. 

For  every  additional  £100  or  fraction  thereof. . .  .Is. 

A  tax  of  1  shilling  per  £100  reduces  to  a  rate  of  V20  of  1%. 
(2)  Drafts  drawn  outside  of  the  United  Kingdom  and 
payable  outside  of  the  United  Kingdom,  are  subject  to  a 
tax  if  negotiated  in  the  United  Kingdom,  payable  at 
the  time  of  the  first  negotiation.  The  rates  of  the  pre- 
ceding schedule  apply  here  upon  drafts  of  £50  or  less, 
while  those  exceeding  £50  but  not  in  excess  of  £100  must 
bear  a  stamp  of  6d.  Still  larger  drafts  pay  6d.  for  every 
additional  £100  or  fraction  thereof.  Tkis  is  at  a  rate  of 
y*o  of  1%. 


CHAPTER  IX 

THE  PURCHASE  OF  BILLS  FOR  DIRECT  CREDIT  TO  THE 
FOREIGN  BALANCE 

§  64.  Buying  bankers'  long  bills. — Though  a  bank  can 
make  arrangements  permitting  it  either  to  buy  or  sell 
bills  on  a  place  where  it  keeps  no  balance,  such  dealings  are 
not  likely  to  be  extensive.  The  present  chapter  will  con- 
cern itself  only  with  dealings  on  a  place  where  a  balance 
is  carried  and  will  be  confined  to  operations  based  directly 
upon  such  balance.  It  will  be  best  to  begin  with  the  pur- 
chase of  a  banker's  long  bill.  This  kind  of  exchange  is 
often  drawn  and  sold  in  large  quantities.  Its  origin  or 
supply  will  be  discussed  in  Chapter  XII.  At  this  point 
we  shall  concern  ourselves  with  the  buying  price  offered 
for  it. 

The  banker  who  buys  another  banker's  long  bill  on  a 
foreign  city  might  conceivably  have  a  mind  to  invest  in  it, 
but  practically  this  is  not  likely  to  be  the  case  because  the 
money  market  and  exchange  conditions  which  lead  to 
regular  drawings  of  this  kind  are  unfavorable  to  invest- 
ment in  exchange.  It  shall  be  assumed,  therefore,  that  the 
bill  is  purchased  with  a  view  to  its  being  discounted  on  its 
arrival  abroad  for  an  immediate  credit  to  the  balance  of 
the  bank  that  has  bought  it. 

Suppose  then  that  a  60  days'  sight  bill  for  £1,000  drawn 
by  a  New  York  bank  on  some  bank  in  London  is  offered 
for  sale  in  New  York.  What  can  the  buyer  pay  for  this 
instrument?  This  will  depend  on  three  factors:  (1)  the 
rate  of  the  day  in  New  York  for  bankers'  sight  sterling 
drafts,  or  in  short  what  is  called  the  sight  rate,   (2)   the 

258 


THE  PURCHASE  OF  BILLS  259 

London  arrival  discount  rate  quoted  this  day  for  60  days 
bankers'  bills,  and  (3)  the  stamp  tax.  The  price  will  first 
be  calculated  that  can  be  paid  for  the  bill  without  the  pur- 
chaser making  either  profit  or  loss.  This  will  give  us  what 
may  be  called  the  no-profit  buying  price,  and  the  amount 
of  this  price  per  pound  of  face  value  of  the  bill,  will  be 
the  no-profit  buying  rate.  If  the  price  of  the  £1,000  bill 
turns  out  to  be  $4,834.00,  the  rate  would  be  4.8340  (i.e., 
$4.8340  per  pound). 

The  sight  rate  in  the  open  market  depends  upon  the  sup- 
ply of  and  demand  for  sight  bills  as  determined  by  the 
needs  of  the  whole  body  of  dealers.  This  supply  and  de- 
mand is  affected  by  the  operations  of  the  market  in  all 
other  kinds  of  exchange  than  sight  bills,  being  profoundly 
influenced  especially  by  the  volume  of  long  bills  originating 
in  trade.  The  manner  in  which  dealings  in  cables  and  long 
bills  react  upon  the  sight  rate  will  be  discussed  in  the 
chapter  on  the  theory  of  exchange  rates.  The  fact  of 
present  concern  is  that  the  position  of  the  rate  for  sight 
drafts  is  governed  primarily  by  the  course  of  the  foreign 
commerce  of  the  nation  and  by  international  borrowings, 
and  is  to  be  taken  by  the  banker,  who  is  figuring  a  buying  or 
selling  price  for  any  other  type  of  exchange,  as  a  predeter- 
mined and  given  factor  in  his  calcidations. 

The  long  bill,  whose  purchase  we  are  about  to  consider, 
will  be  converted  into  cash  credit  for  the  London  balance 
on  its  arrival.  The  rate  payable  for  it  on  this  side  will 
depend  primarily  and  directly  on  the  existing  sight  rate 
because  this  long  bill  will  either  (1)  be  remitted  abroad  ;is 
a  substitute  for  sight  exchange  to  increase  the  foreign 
balance,  or  (2)  it  will  be  used  as  cover  for  a  sale  of  sight 
exchange,  the  latter  being  its  employ ment  if  the  foreign 
balance  is  already  as  large  as  desired.  In  either  ease  what 
the  long  bill  is  worth  in  New  Fork  will  depend  primarily 
upon  what  sight  sterling  is  worth  at  the  time.     The  second 


260  FOREIGN  EXCHANGE 

supposition  is  best  taken  as  the  normal  theoretical  assump- 
tion upon  which  to  calculate  the  buying  price  of  any  long 
exchange.  To  explain:  if  the  purchased  60  days  bill  for 
CI. 000  will  yield  on  arrival  a  cash  credit  of  say  £993  to  the 
buying  banker's  London  balance,  and  if  there  is  no  especial 
reason  at  the  time  for  the  addition  of  this  sum  to  the 
balance,  the  policy  indicated  to  the  banker  is  the  sale  of 
£993  x  of  his  sight  drafts  on  the  local  market — this  policy 
being  founded  upon  what  we  ventured  in  §  52  to  call  the 
rule  of  equal  sales  and  purchases.  Clearly  what  the  long 
bill  is  worth  to  him  depends  upon  what  he  gets  for  the 
sight  drafts  which  it  will  cover,  and  thus  upon  the  sight 
rate.  The  completed  operation  in  theory  consists  of  two 
parts,  (a)  the  purchase  of  the  long  bill  and  (b)  the  counter- 
vailing sale  of  sight  drafts.  One  involves  an  outlay  of 
dollars  and  the  other  a  return  of  dollars.  Together  they 
leave  the  foreign  balance  unchanged,  but  afford  a  profit  on 
this  side  provided  the  long  bill  is  bought  cheap  enough. 

COMPUTATION   IN   UNABBREVIATED    FORM    OF    THE 

NO-PROFIT  BUYING  PRICE   FOR  A  BANKER'S 

LONG  BILL 

Take  a  60  days'  sight  bill  for  £1,000. 

Sight  sterling  rate  (on  day  of  purchase) 4.87 

London  arrival  discount  rate 4% 

Stamp  tax %o% 

No  commission  charges. 

Present  worth  of  the  bill  on  its  arrival  in  London. 

This  bill  becomes  payable  in  London  63  days  after  the  date  of  its 
arrival,  assuming  acceptance  to  be  procured  on  the  day  of 
arrival. 

63  days'  discount  at  4%  will  be  6%65  of  4%  of  £1,000. 
(The  English  count  the  year  as  365  days,  and  not  as  360) 

i  Not  that  it  is  supposed  he  will  in  fact  find  a  purchaser  for  this 
precise  amount.     Whatever  he  sells,  this  particular  long  bill  is  re- 


THE  PURCHASE  OF  BILLS  261 

This  amounts  to  £6  18s.     Id. 

The  present  worth  of  the  bill  is  then  £1,000  less  this 
amount,  or £993     Is.  lid. 

Net  cash  value  of  this  bill  to  the  London  deposit. 

The  stamp  tax  on  the  bill  (Is.  per  £100) 10s. 

This   is   paid   by   the   London    correspondent   and 
charged  to  the  remitting  bank. 

The  present  worth  of  the  bill  as  above £993     Is.  lid. 

which  equals £992  21s.  lid.2 

Less  stamp  tax  10s. 

Net  cash  value  of  the  bill £992  lis.  lid. 

No-profit  purchase  price  of  the  bill  in  dollars. 
Amount  of  demand  draft  that  can  be  sold  against 

this  bill £992  lis.  lid. 

Which  expressed  decimally  is £992.596 

£992.596  X  4.87  (N.  Y.  rate)  = $4,833.94 

No-profit  buying  rate  would  therefore  be  4.8339, 

nearest  standard  quotation  being 4.8340 

Under  the  data  given,  the  computation  shows  that  the 
banker  can  obtain  from  the  long  bill  $4,833.94  cash  return 
in  New  York  on  the  day  he  bought  it.  For  we  may  assume 
that  he  can  sell  the  992  odd  pounds  of  sight  drafts  on 
this  day.  The  two  parcels  of  exchange,  the  long  bill  bought 
and  serving  as  cover  and  the  sight  bill  sold  against  it,  may 
well  cross  the  ocean  by  the  same  steamer.  If  it  were 
necessary  to  give  the  cover  one  day's  start,  the  turnover 
would  be  theoretically  chargeable  with  one  day's  interest  on 
the  cost  of  the  long  bill.  The  bill  yields  a  return  of 
$4,833.94,  and  therefore  if  the  banker  paid  exactly  this 
price  for  it,  or  bought  it  at  the  rate  of  4.8339,  he  would 
make  neither  profit  nor  loss. 

sponsible  for  his  ability  to  draw  exactly  £993  of  demand  drafts,  and 
is  of  course  to  be  valued  accordingly. 

2  Obtained  by  deducting  £1    from  £i)!)3   and  adding  it,  as  20  shil- 
lings to  the  Is.     £1  =20  shillings.      1   shillings:  12  pence,  or  "12d." 


262  FOREIGN  EXCHANGE 

The  account  of  this  operation  is  restated  beneath  in  a 
modified  form. 

A  £1,000,  60  days'  bill  bought  at  4.8339  costs $4,833.90 

It  produces  a  net  (tax  free)  cash  credit  abroad 

on  arrival  of   £992.596 

It  provides  cover  for  the  sale  of  a  demand 

bill  for  this  amount  of  sterling. 
£992.596  demand  exchange  sold  at  4.87  yields 3 $4,833.90 


Profit   (or  loss)    0 

It  is  clear  if  a  profit  is  to  be  obtained  when  the  sight  rate 
is  4.87  and  the  discount  rate  is  4%,  the  bill  must  be  bought 
under  the  rate  of  4.8339.  If,  for  instance,  it  could  be 
bought  at  4.83,  a  profit  of  3%oo  of  1  cent  would  be  made  on 
each  pound.  This  would  be  a  profit  of  about  Vn  of  1%,  or 
$3.90  on  a  bill  for  £1,000.  So  large  a  profit  could  hardly 
be  obtained  in  fact  under  normal  conditions  from  the  pur- 
chase of  a  prime  banker 's  bill. 

The  banker's  practical  method  of  figuring  the  price  of  a 
long  bill  is  briefer  and  more  direct  than  the  one  just  ex- 
plained. It  involves  a  trifling  theoretical  error,4  as  will  be 
shown,  but  we  have  begun  with  the  longer  computation  not 
so  much  because  of  this  fact  as  because  this  longer  form 
enables  one  unfamiliar  with  exchange  to  understand  the 
reasoning  leading  to  the  answer.  The  abbreviated  practical 
computation  is  useful  in  obtaining  the  desired  result, 
namely  a  sufficiently  accurate  answer  to  the  problem,  but 
the  reasoning  underlying  it  is  not  on  the  face  of  it  per- 

3  The  fixed  tax  of  Id.  on  demand  bills,  regardless  of  their  amount, 
is  treated  as  negligible. 

4  The  error  is  trifling  so  long  as  sterling  remains  within  the  nor- 
mal limits  between  4.84  and  4.88.  The  enormous  war-time  fluctua- 
tions of  sterling  in  New  York  have  had  the  effect  of  making  the  error 
very  significant  and  have  forced  bankers  to  abandon  their  old  com- 
puting tables. 


THE  PURCHASE  OF  BILLS  263 

fectly  intelligible.  It  is  given  beneath  for  the  same  bill  and 
date  as  before. 

TEE    PRACTICAL    METHOD    OF    CALCULATING    THE 
PRICE   OF  THE   BANKER'S   60  DAYS'  BILL 

Rate  for  banker's  sight  drafts 4.87 

63  clays'  discount  at  4% 0335 

(Taken  as  6%65  of  4%  of  4.85,  $4.85  being  as- 
sumed as  the  equivalent  of  £1,  so  that  the 
discount  on  £1  may  be  converted  to  U.  S. 
money.) 

Stamp  tax,  at  the  rate  of  ^o% 0024 

(%o  of  1%  of  4.85) 

.0359        .0359 

No-profit  buying  price  of  the  bill  4.8341 

The  discount  and  stamp  tax  appear  in  the  above  tabulation 
as  decimal  fractions  of  an  American  dollar,  but  the  real 
discount  and  tax  are  in  point  of  fact  deductions  (from  the 
face  or  maturity  value  of  the  long  bill)  made  in  London 
and  in  sterling  money.  They  are  really  subtracted  to  find 
the  net  spot-cash  value  of  the  bill  to  the  remitting  bank'?. 
London  balance.  The  amount  of  discount  and  tax  for  each 
pound  of  the  long  bill  may  be  figured  quite  as  easily  as 
for  the  whole  sum  due  upon  it.     Thus, 

The  discount  on  each  pound £.0069 

6%G5  of  4%  of  £1 
The  stamp  tax  on  each  pound 0005 

%o  of  1%  of  £1 

Total    0074 

When  we  speak  of  a  pound  of  long  bill  we  mean  a  pound 
of  its  face  value.  If  such  a  bill  converted,  on  arrival  in 
London,  into  cash  credit  without  the  deductions  of  discount 
and  tax,  so  that  each  pound  of  it  produced  a  full  pound 


264  FOREIGN  EXCHANGE 

of  cash  credit,  it  would  be  worth  $4.87  per  pound  in  New 
York  on  the  day  of  purchase,  provided  the  sight  rate  stood 
at  4. ST  on  that  day.  But  in  this  conversion  into  cash  credit, 
each  pound  Buffers  the  deductions  for  discount  and  tax 
calculated  above.  On  the  basis  of  these  data  we  can  per- 
form the  following  modified  computation  to  find  its  worth 
(or  no-profit  buying  price)  in  New  York. 

Value  of  each  pound  of  long  hill  without  allow- 
ance for  the  deductions  due  to  discount  and  tax.   $4.87 

Loss  in  dollars  for  the  deduction  of  the 

discount    .033603 

(.0069X4.87) 
Explanation: — £.0069   being  taken   out 

for   discount  means  £.0069  less  of  sight 

exchange  saleable  against  £1  face  value  of 

the  long  bill,  and  a  consequent  giving  up 

of  .0069  X  $4-87. 

Loss  in  dollars  for  the  deduction  of  the 

stamp  tax   .002435 

(.0005X4.87) 
Explanation: — The  same  as  above. 

Total  loss  or  deductions 036038       .030038 

Net  value  of  each  pound 4.833962 

The  following  computation  is  arithmetically  identical  with 
the  foregoing. 

Sight  rate 4.87 

63  days'  discount  at  4% 033603 

6%65  of  4%  of  4.87 

The  same  as  .0069  X  4.87 
Stamp  tax  at  rate  of  %o% 002435 

%o  of  1%  of  4.87 

The  same  as  .0005  X  4.87 

.030038  .036038 

4.833962 


THE  PURCHASE  OF  BILLS  265 

This  reckoning  is  strictly  correct.  It  differs  from  the 
banker's  practical  computation  (given  on  pages  64-6)  only 
in  that  it  makes  use  of  4.87,  namely  the  existing  sight  rate, 
in  converting  the  discount  and  tax  into  dollars,  whereas 
the  banker  uses  the  fixed  figure  4.85  for  this  purpose.5  It 
is  this  use  of  4.85  as  a  constant  which  brings  into  the  prac- 
tical computation  the  trifling  error  of  which  we  spoke. 
To  obtain  perfect  accuracy  the  existing  sight  rate  must 
always  be  employed  in  the  foregoing  conversions.  It  is 
only  when  the  sight  rate  happens  to  stand  at  4.85  that  the 
banker's  calculation  is  absolutely  exact. 

In  the  illustration  before  us,  the  practical  method  gives 
a  no-profit  price  that  errs  by  being  too  high.     Thus, 

No-profit  rate 

According  to  the  practical  method $4.8341 

According  to  the  true  method 4.833962 

Difference 000138 

Though  so  small,  this  error  would  mean  that  on  £100,000 
of  60  days'  bills  bought  under  the  conditions  of  our  illustra- 
tion the  banker  would  figure  his  buying  price  $13.80  too 
high  for  the  whole  lot.  When  the  sight  rate  is  below  4.85 
the  practical  method  makes  the  buying  price  come  out  too 
low  and  causes  the  dealer  to  obtain  slightly  more  profit  in 
the  purchase  of  long  bills  than  his  computations  show  on  the 
surface. 

The  reason  justifying  the  use  of  4.85  as  a  constant  is 
simply  one  of  convenience.  On  the  basis  of  this  figure  a 
single  table  can  be  prepared  which  will  show  at  a  glance  the 
amount  of  deduction  in  dollars  to  be  made  for  discount  at 
all  the  various  rates  of  discount  commonly  quoted  and  for 
all  the  different  length  of  life  of  bills  ordinarily  bought. 

c  Or  did  so  prior  to  the  war,  when  sterling  rates  remained  within 
their  normal  limits,  generally  between  4.84  and  4.88+. 


266  FOREIGN  EXCHANGE 

Tables  founded  on  the  correct  method  could  be  computed 
for  all  different  sight  rates  met  with  in  practice,  but  the 
single  table  has  apparently  seemed  sufficiently  accurate  to 
actual  dealers.  Theoretically  the  stamp  tax  converted  to 
dollars  is  also  variable  with  the  existing  sight  rate,  but 
bankers  are  content  to  subtract  the  constant  .0024,  based 
on  4.85. 

§  65.  Buying  long  bills  drawn  by  merchants  on  banks. — 
Having  explained  both  the  true  and  the  practical  methods, 
we  shall  be  content  henceforth  to  follow  the  latter  alone. 
Suppose  for  the  next  problem  that  an  American  exporter 
offers  for  sale  his  90  days'  documentary  draft  upon  a 
London  bank,  drawn  under  a  latter  of  credit,  when  the 
arrival  discount  rate  for  such  a  bill  is  3%  and  the  sight 
rate  is  4.85.  What  price  will  a  local  exchange  bank  offer 
for  this  bill?  When  this  instrument  becomes  the  accept- 
ance of  the  London  bank,  which  we  may  assume  to  be  one 
in  first  class  standing,  it  becomes  a  prime  bill.     As  such  it 

BANKER'S  BUYING  PRICE  FOR  MERCHANT'S  90  DAYS' 
SIGHT  DRAFT  ON  LONDON  BANK 

Sight  rate,  or  rate  for  banker's  sight  drafts 4.85 

93  days'  discount  at  3%  0371 

(9%6sX3%  of  4.85) 
Stamp  tax  0024 

06o  of  1%  of  4.85) 
Correspondent  bank's  commission 0012 

(Taken  as  Mo  of  1%  of  4.85) 

.0407         .0407 


Buying  price  at  which  the  bank  would  make  no  profit 4.8093 

Profit  required,  a  variable,  say  M  cent  per  £ 0025 

Rate  yielding  this  profit 4.8068 

Nearest  standard  rate 4.8070 


THE  PURCHASE  OF  BILLS  2G7 

will  be  entitled  to  the  lowest  rate  of  discount  for  90  days' 
paper  in  the  London  market.  This  fact  will  have  been 
taken  into  consideration  by  the  correspondent  of  the  buying 
bank,  at  the  time  when  this  correspondent  named  an  ar- 
rival rate  of  3%.  The  documents  will,  of  course,  be  "for 
acceptance"  and  after  the  act  of  acceptance  takes  place  the 
bill  will  become  a  "clean"  one. 

In  addition  to  discount  and  stamp  tax,  commission  ap- 
pears as  a  new  deduction  in  this  computation.  We  assume 
the  correspondent  charges  the  remitting  bank  a  commis- 
sion at  the  rate  of  Mo  of  1%,  upon  this  bill  because  of 
the  attached  documents  which  it  has  to  handle. 

The  deductions  of  .0407  plus  the  profit  of  .0025  make 
the  difference  between  the  sight  rate  and  the  buying  rate 
quoted  for  this  bill  come  to  .0432.  Such  a  difference  is 
sometimes  called  the  "spread."  So  long  as  discount,  tax, 
and  commission  are  at  the  same  rates,  and  the  profit  exacted 
remains  the  same,  the  spread  is  a  constant  no  matter  what 
the  sight  rate  may  be.  That  is,  it  figures  as  a  perfect 
constant  under  the  practical  method  of  computation,  and 
it  will  be  a  virtual  though  not  perfect  constant  under  the 
theoretically  correct  method.  Thus  under  the  practical 
method,  any  of  the  following  computations  hold  good. 

Sight  rate 4.88  4.8G50         4.85  4.84 

Spread 0432  .0432  .0432  .0432 


Buying  rate  ....  4.83G8        4.8218        4.8068        4.79G8 

§  66.  Trade  bills,  documents  for  acceptance. — By  a  trade 
bill  is  meant,  at  least  in  this  connection,  one  drawn  by  a 
merchant  on  a  merchant.  This  is  the  kind  of  bill  con- 
sidered at  length  in  Chapter  VI.  It  becomes  the  accept- 
ance of  a  merchant  or  mercantile  house,  and  not  the  accept- 
ance of  a  bank  or  of  an  acceptance  house  with  a  standing 
practically  equal  to  that  of  a  bank.     In  the  case  of  most 


268  FOREIGN  EXCHANGE 

trade  bills,  documents  are  "for  payment,"  but  if  the  drawee 
has  a  sufficiently  high  standing:  they  may  be  "for  accept- 
ance" as  is  assumed  in  this  problem.  In  this  instance, 
then,  the  bill  will  after  acceptance  become  clean  and  will 
be  discountable  in  London  at  a  rate  depending  on  the  stand- 
ing of  the  acceptor.  Assume  that  the  arrival  rate  under 
which  the  bill  in  hand  is  sent  over  is  3%%. 

BANKER'S  BUYING  RATE  FOR  MERCHANT'S  90  DAYS' 

SIGHT  BILL  ON  A  MERCHANT,  DOCUMENTS 

FOR  ACCEPTANCE 

Sight  rate 4.85 

93  days'  discount  at  3^%  0433 

Stamp  tax 0024 

Commission   0012 

.0469        .0469 

No-profit  buying  rate 4.8031 

Profit  required,  variable,  say  %  cents  per  £ 0037 


4.7994 
Nearest  standard  rate,  4.7995. 

§  67.  Trade  bills,  documents  for  payment. — As  already 
explained  (compare  §  34),  the  "documentary  payment  bill" 
is  a  trade  bill  whose  attached  documents  are  deliverable 
to  the  drawee  only  in  return  for  payment  of  the  instrument. 
Calculation  of  the  buying  rate  for  such  a  bill  is  a  problem 
distinct  from  any  considered  in  the  preceding  sections,  for 
the  reason  that  it  cannot  be  discounted  in  England  when 
sent  to  that  country  by  the  bank  which  has  purchased  it. 
This  is  a  matter  of  the  banking  custom  of  England  which, 
it  happens,  is  in  contrast  with  that  of  the  principal  con- 
tinental European  countries.  It  has  been  stated  in  another 
place  (see  §35)  that  the  acceptor  of  a  documentary  pay- 


THE  PURCHASE  OF  BILLS  269 

ment  bill  has  the  privilege  of  prepayment  under  the  rebate 
rate  at  any  time  during  the  life  of  the  instrument.  He 
may  also  at  his  own  option  allow  it  to  run  till  maturity. 
The  reason  why  English  banks  do  not  care  to  discount  bills 
of  this  class  4s  presumably  because  they  do  not  desire  to 
have  among  their  assets  pieces  of  paper  with  uncertain  dates 
of  payment,  though  the  custom  is  perhaps  in  part  attribut- 
able to  the  fact  that  these  bills  are  in  general  drawn  upon 
persons  or  firms  of  lower  financial  standing  than  those  upon 
which  the  discountable  classes  of  bills  are  drawn.  It  is 
true  the  legal  date  of  maturitjr  of  a  documentary  payment 
bill  is  fixed,  being  commonly  a  date  such  and  such  a  number 
of  days  after  acceptance,  and  thus  the  bill  has  full  legal 
negotiability,6  but  its  date  of  actual  discharge  depends 
nevertheless  upon  the  wishes  of  the  acceptor.  Also  retire- 
ment takes  place  at  a  rate  of  discount  which  is  not  of  the 
holder's  making. 

But  if  the  correspondent  will  not  buy  this  instrument, 
why  not  have  it  sold  on  the  open  market.  In  the  first 
place  the  bill  dealers  would  not  buy  what  the  banks  refuse, 
because  they  rely  so  much  upon  rediscount  with  the  banks. 
In  the  second  place  there  is  a  particular  practical  difficulty 
in  the  way  of  this  plan,  which  is  sufficient  to  make  its  re- 
jection necessary.  If  the  bill  were  sold  to  any  one,  the 
documents  would  have  to  accompany  it  so  that  he  would 
be  able  to  present  them  to  the  acceptor  when  demanding 
payment  at  maturity.  But  if  the  bill  were  to  go  into  the 
market  with  documents  attached,  the  acceptor  would  have 
to  be  able  to  follow  it  up  and  locate  it  in  order  to  exercise 

o  As  already  indicated  (compare  §§5  and  9),  one  of  the  require- 
ments which  a  bill  or  note  has  to  meet  in  order  to  possess  strict 
negotiability,  is  that  it  must  be  "payable  on  demand,  or  at  a  fixed 
or  determinable  future  time."  There  is  no  reason  to  suppose  that 
the  extra-legal  commercial  custom  of  prepayment  destroys  technical 
negotiability. 


270  FOREIGN  EXCHANGE 

his  right  of  prepayment,  and  this  might  be  an  annoyance 
to  say  the  least.  So  tin*  instrument  stays  with  the  corre- 
spondent bank  which  first  received  it  from  abroad  and 
presented  it  for  acceptance,  but  stays  as  the  property  of  the 
foreign  banker  who  bought  it  as  exchange.7 

In  purchasing  this  class  of  exchange,  then,  the  American 
bank  is  confronted  with  the  problem  that,  in  general,  it 
cannot  be  certain  whether  the  bill  will  remain  unpaid  till 
maturity,  or  will  be  converted  into  cash  credit  upon  or  some 
time  after  arrival.  This  is  a  problem  because  the  value  of 
the  bill  as  a  purchase  on  this  side  of  the  water  differs 
according  to  which  of  these  alternatives  is  realized.  Thus, 
under  given  circumstances,  if  the  bill  were  to  be  retired 
promptly  it  might  be  worth  say  4.83,  while  if  it  were  to  be 
allowed  to  mature  it  would  be  worth  perhaps  only  4.8240. 

The  American  banker  to  whom  one  of  these  bills  is  of- 
fered by  the  drawer,  may  decline  to  purchase  it  and  may  be 
willing  to  take  it  only  for  collection.  If  he  does  purchase, 
however,  the  problem  of  calculating  the  buying  rate  is  some- 
what more  complex  than  in  any  of  the  cases  we  have  hereto- 
fore considered.  A  sale  by  the  banker  of  his  own  long 
sterling  bill,  or  again  the  sale  of  his  sight  draft  for  future 
delivery,  may  be  involved.  For  this  reason  it  will  be  advis- 
able to  postpone  explanation  of  this  particular  calculation 
until  these  more  technical  operations  involved  have  been 
brought  under  examination.     (See  §  94.) 

Why  clean  bills  alone  are  discountable  in  London. — A 
"clean"  bill  is  one  without  documents  attached,  whether  it 
is  one  originally  drawn  without  documents,  or  is  a  docu- 
mentary bill  which  has  at  the  time  of  acceptance  been 
stripped  of  documents.     It  is  sometimes  stated  that  London 

i  It  is  difficult  to  see  any  positively  compelling  reason  why  British 
correspondent  banks  should  not  buy  drafts  of  this  kind,  the  standing 
of  the  drawers  being  assumed,  and  hold  them  until  payment  actually 
takes  place,  thus  following  the  custom  of  continental  banks. 


THE  PURCHASE  OF  BILLS  271 

discounts  only  clean  bills.  This  is  true,  but  at  first  blush 
appears  puzzling  because  a  clean  bill  would  in  the  abstract 
seem  to  be,  from  the  point  of  view  of  security,  inferior  to 
a  documentary  bill.  The  answer  to  this  enigma  is  not 
that  some  of  the  security  must  be  stripped  off  a  bill  before 
the  London  market  will  accept  it  for  discount,  but  the 
explanation  runs  rather  in  this  wise:  No  bill  drawn  on 
England  is  likely  to  be  discounted  in  regular  course  until 
it  is  accepted.  Documentary  bills  drawn  on  banks  are 
always  governed  by  the  instructions  "documents  for  ac- 
ceptance," and  therefore  always  become  clean  before  they 
become  available  for  discount.  Where  documentary  bills 
drawn  on  merchants  are  under  the  same  instructions,  the 
identical  observation  applies.  Where  trade  bills  are  drawn 
"documents  for  payment,"  they  do  not  become  clean  upon 
acceptance.  This,  the  only  type  of  bill  which  is  not  clean 
after  acceptance,  happens  to  be  non-discountable  because 
of  the  retirement  privilege  which  belongs  to  the  drawee. 
Thus  only  bills  which  are  clean  of  documents  are  in  fact 
discountable. 

§  68.  Selling  sight  drafts  and  cables. — The  preceding  sec- 
tions have  made  it  clear  that  the  buying  rates  for  many 
classes  of  bills  are  calculated  on  the  assumption  that  each 
purchase  of  exchange  is  to  have  associated  with  it  a  simul- 
taneous countervailing  sale  of  sight  drafts  on  the  open 
market  by  the  purchasing  banker.  If  some  of  these  drafts 
are  sold  to  merchant  customers  of  the  banker  rather  than 
on  the  open  market,  the  principle  of  the  calculation  re- 
mains unchanged.  Obviously  in  practice  each  distinct  pur- 
chase need  not  be  accompanied  by  an  individually  corre- 
sponding sale,  it  being  sufficient  for  the  total  of  current 
sales  to  be  kept  running  on  a  basis  of  substantial  equality 
with  the  total  of  current  purchases.  The  reasons  for  the 
maintenance  of  this  equality  as  a  general  policy,  were  dis- 
cussed in  connection  with  what  we  called  the  rule  of  equal 


272  FOREIGN  EXCHANGE 

sales  and  purchases.  The  banker  departs  from  this  policy 
whenever  lie  desires  to  increase  or  decrease  his  foreign  bal- 
ance or  other  foreign  funds,  selling  less  exchange  than  he 
buys  if  he  wishes  to  effect  an  increase  of  these  funds,  and 
following  a  reverse  plan  to  produce  an  opposite  result.  But 
even  when  the  equality  of  sales  and  purchases  is  purpose- 
fully suspended  by  the  banker,  the  principle  of  determining 
the  buying  rates  remains  unaltered.  If  the  banker  desires 
to  buy  more  exchange  than  he  sells,  he  can  obtain  bankers' 
sight  drafts  at  the  open  market  rate.  Under  the  condi- 
tions he  may  be  inclined  to  look  upon  the  purchase  of  a 
long  bill  as  a  substitute  for  a  purchase  of  sight  drafts  on 
the  open  market,  rather  than  as  an  operation  to  be  counter- 
balanced by  a  sale  of  his  own  sight  drafts;  but  the  value 
of  the  long  bill  as  a  purchase  will  properly  be  calculated 
according  to  precisely  the  same  method  as  before.  That 
is,  discount,  tax,  commission  (if  any),  and  profit  (if  any), 
enter  into  the  computation  in  the  same  manner  as  before. 
Profit  is  the  only  one  among  these  factors  about  which  there 
might  be  a  question.  In  his  desire  to  procure  exchange, 
might  not  the  banker  sacrifice  the  profit  he  ordinarily  de- 
mands when  purchasing  certain  types  of  bills  ?  This  ques- 
tion ignores  the  fact  that  all  the  bankers'  sight  drafts 
needed  can  be  procured  at  the  market  rate,  if  it  is  a  real 
market  rate,  and  that  there  is  as  much  reason  as  ever  for 
exacting  the  margin  of  profit  that  competition  tolerates  on 
other  classes  of  exchange.  Risk  and  trouble  are  the  foun- 
dations on  which  this  profit  rests,  and  they  are  the  same 
whether  the  exchange  be  bought  as  a  substitute  for  bankers' 
sight  bills  or  as  cover  for  a  sale  of  them.  If,  to  reverse 
the  case,  the  banker  is  at  the  moment  engaged  in  selling 
more  exchange  than  he  buys,  there  is  obviously  no  reason 
why  he  should  reduce  the  margin  of  profit  on  purchases, 
and  there  is  no  reason  why  he  may  expect  to  secure  a  larger 
profit. 


THE  PURCHASE  OF  BILLS  273 

While  we  are  seeking  to  establish  the  principle  that  buy- 
ing rates  for  leading  classes  of  long  exchange  are  calculable 
on  the  uniform  assumption  of  a  countervailing  sale  of 
sight  drafts  at  the  open  market  rate,  we  may  be  required 
to  consider  two  further  questions,  namely,  (1)  what  deter- 
mines the  open  market  rate  for  sight  drafts,  and  (2)  why 
may  not  the  countervailing  sale  of  exchange  take  the  form 
of  a  sale  of  cables  and  the  buying  rate  be  calculated  from 
the  cable  rate  as  basis?  The  first  question  can  profitably 
be  discussed  at  length  only  near  the  close  of  the  book,  but 
it  may  be  said  here  that  the  sight  rate  itself  depends  in 
the  end  upon  the  totality  of  the  supply  of  and  demand 
for  all  classes  of  foreign  exchange  as  determined  primarily 
by  international  commercial  and  financial  traffic,  and  sec- 
ondarily by  exchange  investment,  borrowing,  speculation, 
and  arbitrage,  and  the  export  and  import  of  specie. 

As  for  the  second  question,  to  wit,  why  not  calculate  all 
buying  rates  for  bills  on  the  basis  of  the  market  rate  for 
cables,  it  must  be  confessed  the  thought  that  the  cable  rate 
is  the  "real"  exchange  rate,  unadulterated  by  discount  or 
interest,  so  to  speak,  is  an  attractive  idea  to  both  the  theorist 
and  the  banker.  But  be  this  as  it  may,  the  various  long 
rates  (and  also  the  rates  for  merchants'  sight  bills,  which 
are  sometimes  drawn)  are  tied  to  the  rate  for  bankers' 
sight  drafts  in  a  way  in  which  they  cannot  be  connected 
with  the  cable  rate.8  The  spread  between  a  long  rate  and 
the  sight  rate  can  be  calculated  at  the  time  of  the  purchase 
of  the  long  exchange,  from  factors  which  are  then  all  fore- 

8  The  rates  for  documentary  payment  bills  are  somewhat  loosely 
related  to  the  sight  rate  but  are  still  more  loosely  related  to  the 
cable  rate.  The  theorist  might  express  himself  figuratively  by 
saying  that  under  normal  conditions,  when  the  mechanism  of  the  ex- 
changes is  freely  operative,  the  undoubted  focus  upon  which  the 
forces  of  exchange  supply  and  demand  are  concentrated  is  the  so- 
called  market  sight  rate,  namely  the  rate  for  bankers'  sight  drafts. 


•74  FOREIGN  EXCHANGE 

known.9  Neither  speculation  nor  investment  enters  in. 
But.  the  purchase  of  any  kind  of  bill  cannot  be  counter- 
balanced by  a  sale  of  cables  without  both  a  speculation 
and  an  investment,  of  funds  being  involved.10  And  so  a 
banker  cannot  base  his  buying  rate  for  long  bills  upon  the 
cable  rate  without  putting  into  the  spread  one  speculative 
element,  or  one  factor  that  is  guesswork.  The  point  re- 
mains even  if  under  very  quiet  conditions  the  degree  of 
speculation  may  be  slight.  Why  the  speculative  factor  is 
necessarily  present  will  be  shown  in  §  155. 

The  rates  for  exchange  which  takes  the  form  of  written 
instruments  that  have  to  be  transmitted  by  mail  to  the 
place  where  they  are  payable,  happen  then  to  be  more  in- 
timately connected  with  each  other  than  with  the  rate  for 
telegraphic  transfers.  The  sight  rate  is  basic  among  this 
larger  group.  The  sight  rate  and  the  cable  rate  are  re- 
lated, but  the  spread  between  them  contains  an  ineradicable 
speculative  element.  Whether  the  cable  rate  is  in  some 
theoretical  sense  the  basic  one  as  between  these  two,  is  a 
question  that  it  is  practically  idle  to  discuss.  In  point  of 
fact  the  sight  rate  is  not  determined  by  a  calculation  from 
the  cable  rate,  but  is  forged  out  in  the  open  market  between 
the  hammer  and  anvil  of  bid  and  offer.  Under  ordinary 
conditions  at  least,  the  market  would  no  more  think  of  cal- 
culating sight  rates  from  cable  rates  than  the  tail  would 
think  of  wagging  the  dog. 

a  Assuming  the  quotation  of  an  "arrival"  discount  rate. 

io  The  exception  to  this  for  practical  purposes  would  appear  when 
the  place  where  the  bills  are  payable  is  so  near  to  the  place  where 
they  are  drawn,  that  the  mail  for  which  the  bills  are  sold  can  reach 
the  former  on  the  same  day  as  a  telegraphic  transfer. 


CHAPTER  X 
DEALINGS  OF  A  MORE  INVOLVED  CHARACTER 

§  69.  The  bill  drawn  on  a  foreign  country  in  home  money. 
— The  foreign  bill  as  heretofore  considered  in  this  book 
has  been  an  instrument  calling  for  a  specified  sum  of  the 
money  of  the  country  upon  which  it  is  drawn  or  where  it 
is  payable.  But  a  bill  may  be  drawn  for  a  sum  of  the 
money  of  the  country  of  its  origin  or  even  of  a  third  coun- 
try. It  now  becomes  appropriate  to  examine  into  these  to 
us  new  forms  of  exchange.  We  may  attend  first  to  the 
bill  for  a  stipulated  amount  of  the  money  of  the  country 
of  its  origin,  or  the  bill  "drawn  on  a  foreign  country  in 
home  money."  Beneath  is  a  specimen,  to  the  order  of  a 
fictitious  banking  institution  assumed  to  have  offices  both  in 
New  York  and  Rio  Janeiro. 

$8,206.66  New  York,  N.  Y.,  July  1,  1917. 

90  days  after  sight  of  this  First  of  Exchange  (second  unpaid) 
pay  to  the  order  of  the  South  American  Banking  Corporation, 
Eight  Thousand  and  Six  Dollars  and  Sixty-six  Cents,  United 
States  gold,  payable  in  Brazilian  currency  at  the  said  bank's 
drawing  rate  on  the  day  of  payment  for  sight  drafts  on  New  York. 
Value  received  per  S.S.  Southern  Star. 

Brown  and  Company. 

To  Gonzales  &  Gallegos, 
Rio  Janeiro. 

This  instrument  arises  out  of  a  shipment  from  Brown 
and  Company  to  Gonzales  and  Gallegos  of  goods  priced  at 
$8,000,  money  of  the  United  States,  due  the  exporter  in 
New  York  on  the  day  of  shipment,  interest  at  6%  being 

275 


276  FOREIGN  EXCHANGE 

chargeable  for  any  delay  in  payment.  It  is  understood 
Bettlemenl  is  to  be  effected  by  draft  at  90  days'  sight  (the 
usual  term  of  drafts  of  this  eharacter  on  South  America), 
drawn  by  the  exporter  on  the  importer  in  dollars.  The 
draft  is  to  be  payable  at  the  rate  in  Rio  for  sight  drafts 
on  New  York,  which  means  that  it  is  to  be  dischargeable 
by  the  drawee's  handing  over  at  maturity  a  sufficient  sum 
of  Brazilian  money  to  purchase,  at  that  moment  in  Rio, 
a  sight  draft  on  New  York  for  the  number  of  dollars 
stipulated,  in  the  instance  in  hand  $8206.66.  It  is  the 
stipulation  of  the  number  of  dollars  of  this  return  draft, 
as  we  shall  call  it,  which  gives  the  exporter's  original  bill 
on  Brazil  its  distinctive  character.  The  object  of  this  stipu- 
lation is  to  throw  all  risk  of  exchange  upon  the  importer. 
The  exporter  draws  for  a  specified  sum  of  dollars  instead 
of  a  specified  sum  of  milreis.  Were  he  to  draw  in  the 
latter  form,  the  proceeds  from  the  collection  of  the  bill 
might  well  be  used  in  Brazil  to  purchase  a  return  draft  on 
New  York,  but  the  exact  dollar  content  of  this  draft  could 
not  be  foretold,  and  the  exporter  would  take  the  risk  of 
exchange. 

The  sum  of  dollars  named  in  the  exporter 's  original  draft 
is  computed  on  the  assumption  that  a  certain  number  of 
days  will  elapse  before  the  return  draft  reaches  New  York, 
for  which  interest  is  chargeable  at  an  agreed  rate.  That 
is,  the  dollars  drawn  for  include  the  price  of  the  goods, 
payable  as  of  the  date  of  shipment,  plus  interest  on  the 
same  for  time  to  elapse  before  New  York  exchange  is  ex- 
pected to  arrive  in  final  payment.  The  commission  charged 
by  the  banker  for  collection  of  the  exporter's  draft  is  also 
included,  and  this  is  done  whether  or  not  the  banker  sub- 
sequently makes  an  outright  purchase  of  the  draft  instead 
of  receiving  it  for  collection  only.  The  face  value  in  dol- 
lars of  the  draft  of  our  illustration  is  computed  in  the  fol- 
lowing manner: 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      277 

Price  of  goods $8,000.00 

(Under  the  agreement  of  sale,  this  is  amount  due 
the  exporter  as  of  the  date  of  shipment.) 

Interest  on  this  for  140  days  at  6% 186.66 

(6%  is  the  rate  customary  in  these  transactions.) 
The  assumed  period  of  140  days  is  based  on  the 
following  estimates: 

Mail  time  of  draft  to  Rio 25  days 

Period  from  acceptance  to  maturity  90  days 
Mail  time  return  draft  to  N.  Y 25  days 

140  days 

Banker's  commission  at  1/4% 20.00 

(Taken,  as  a  matter  of  usage,  as  Vk%  of  $8,000, 
or  the  price  of  the  goods,  instead  of  V±%  of 
$8,186.66.) 


Total  amount  drawn  for $8,206.66 

This  draft  is  drawn  payable  to  the  order  of  the  South 
American  Banking  Corporation  either  because  this  institu- 
tion is  to  purchase  it  or  to  take  it  for  collection.  In  the 
one  case  the  exporter  will  receive  $8,000  (or  approximately 
$8,000)  of  cash  on  the  day  of  shipment,  while  in  the  other 
his  takings  will  be  $8186.66  (or  $8206.66  less  $20.00  com- 
mission) but  these  will  be  deferred  about  140  days.  The 
life  history  of  the  draft  will  be  in  its  greater  part  the  same 
under  either  supposition.  The  New  York  office  of  the 
South  American  Banking  Corporation  will  forward  it  by 
the  earliest  mail  to  the  branch  at  Rio,  which  will  make  the 
presentment  to  the  drawee  for  acceptance,  this  being 
granted,  we  may  suppose,  on  July  25th,  fixing  the  date  of 
maturity  as  October  23d.  While  the  draft  is  drawn  for  a 
stipulated  sum  of  dollars,  the  acceptor  could  not  in  regular 
course  make  an  actual  payment  of  money  of  the  United 
States  to  discharge  it,  such  money  not  being  in  circulation 
in  Brazil.     To  meet  the  requirements  of  the  case  the  in- 


278  FOREIGN  EXCHANGE 

strument  itself  states  the  dollars  arc  "payable  in  Brazilian 
currency  at  the  drawing  rate  on  the  day  of  payment  for 

sight  drafts  on  New  York."  "Drawing  rate"  is  but  an- 
other name  for  the  selling  rate  of  a  bank. 

At  the  time  of  acceptance  the  precise  number  of  milreis 
that  will  be  required  to  discharge  the  bill  cannot  be  fore- 
told. It  will  depend  upon  the  rate  in  Rio  for  exchange 
on  New  York  at  the  time  of  payment.  There  might  of 
course  be  two  or  more  slightly  differing  rates  on  New  York 
at  any  one  time.  To  obviate  the  danger  of  dispute,  the 
bill  names  the  selling  rate  of  the  Rio  branch  of  the  South 
American  Banking  Corporation  itself.  Should  this  be  4 
milreis  per  dollar,  Gonzales  and  Gallegos  will  discharge 
their  acceptance,  on  October  23d,  by  the  payment  of 
32,826.64  milreis  (4x8206.66),  written  32,826*640,  Bra- 
zilian fashion.  Upon  the  receipt  of  this  sum  the  bank  at 
Rio  draws  its  sight  draft  on  New  York  for  $8206.66  and 
mails  it  to  the  office  or  branch  at  New  York  for  the  account 
of  the  exporter  or  any  party  holding  from  him.1 

The  interest  charge  in  the  present  illustration  was  com- 
puted on  the  assumption  that  140  days  would  elapse  be- 
tween the  date  of  shipment  and  the  arrival  of  the  returns 
in  New  York.  In  point  of  fact  the  return  draft  (or  ticket 
of  advice  which  may  be  substituted  for  it)  might  arrive 
in  advance  of  the  assumed  date.  This  would  depend  upon 
steamer  connections  and  minor  circumstances.  The  time 
allowance  is  made  somewhat  liberal,  but  of  course  cannot 
be  extended  too  greatly  without  unfair  treatment  of  the 
importer.  The  importer's  inpayment  of  milreis  at  Rio 
on  the  date  of  maturity  of  his  acceptance,  could  of  course 

i  In  the  precise  case  before  us  the  actual  return  draft  would 
generally  be  omitted,  for  the  instrument  would  be  drawn  by  the  Rio 
office  of  a  given  bank  upon  the  New  York  office  and  in  favor  of  the 
New  York  office  of  the  same  bank,  so  that  the  transaction  as  between 
the  banks  can  be  settled  by  the  mere  interchange  of  advices  and 
making  of  book  entries. 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      279 

be  converted  into  dollars  of  bank  credit  in  New  York  by  a 
cable  order  (taking  the  place  of  a  draft  or  advice  trans- 
mitted by  mail),  but  this  would  be  done  only  in  case  the 
exporter's  original  draft  stipulated  that  the  dollars  were 
payable  at  the  cable  rate  in  Rio  on  New  York,  which  is  not 
customary. 

As  has  been  stated,  the  reason  why  our  exporters  insist 
upon  bills  in  dollars,  when  drawing  upon  Brazil,  is  that 
they  wish  to  avoid  the  risk  of  exchange  which  would  be 
involved  in  the  issue  of  bills  for  milreis.  This  risk  is  espe- 
cially great  because  Brazil  has  not  as  yet  definitely  adopted 
the  gold  standard,  and  the  number  of  dollars  into  which  a 
given  sum  of  milreis  can  be  converted  is  still  open  to  great 
fluctuations.  By  drawing  for  dollars  our  exporter  does  not 
eliminate  the  risk  of  exchange  from  the  settlement,  but  what 
he  accomplishes  is  to  shift  it  entirely  to  the  importer.  He 
contrives  to  make  determinate  the  number  of  dollars  re- 
ceived for  his  goods,  this  at  the  expense  of  making  the 
number  of  milreis,  that  the  Brazilian  will  have  to  pay  in 
settlement,  indeterminate  until  the  day  of  settlement,  when 
it  will  be  fixed  by  the  then  current  rate  in  Brazil  for  ex- 
change on  New  York.2 

To  carry  the  argument  further,  suppose  our  exporter 
has  quoted  the  price  of  his  wares  as  32,850  milreis,  payable 
90  days  after  arrival  of  a  draft  for  this  amount.  Main- 
taining the  illustration  otherwise  unchanged,  he  would  on 
July  1st  draw  a  90  days'  sight  draft  for  32,850  milreis, 
which  would  be  accepted  on  July  25th  and  fall  due  on 
October  23d.  On  the  latter  date  this  sum  of  milreis  would 
be  paid  into  a  Rio  bank  for  his  account.  The  only  use 
he  could  make  of  it — special  circumstances  apart — would 
be  to  have  this  bank  convert  it  into  a  dollar  draft  on  New 
York  to  be  forwarded  to  him  or  to  his  banker  in  New  York. 

2  The  Brazilian  may,  however,  make  a  hedge  at  any  time  hy  pur- 
chasing New  York  exchange  for  future  delivery. 


280  FOREIGN  EXCHANGE 

The  number  of  dollars  in  this  draft  would  depend  on  the 
rate  of  the  day  in  Rio  for  drafts  on  New  York.  If  the 
rate  turned  out  to  be  4  milreis  per  dollar,  the  return  draft 
would  be  for  $8212.50  (assuming  that  bankers'  commissions 
are  collected  in  New  York)  ;  if  it  turned  out  to  be  414 
milreis  per  dollar,  the  draft  would  be  for  $7729.41  which  is 
nearly  $500  less.  Thus  a  rise  in  the  rate  at  Rio  upon  New 
York  would  be  unfavorable  to  the  exporter.  A  reverse 
movement,  it  is  true,  would  yield  him  an  extra  gain,  but 
he  does  not  desire  to  take  a  speculation  upon  the  course 
of  this  rate.  If  he  drew  at  sight  instead  of  at  90  days' 
sight,  the  risk  would  still  be  present,  though  the  period 
during  which  the  exchange  rate  might  vary  would  be  90 
days  shorter.  The  question  arises,  could  not  the  exporter 
protect  himself  against  the  risk  of  exchange  by  charging  a 
sufficiently  high  price  in  milreis  ?  He  could,  but  this  would 
still  leave  him  involved  in  the  making  of  exchange  prog- 
nostications— in  a  word,  in  exchange  speculations — and 
whether  or  not  he  could  get  business  on  this  method,  it  is 
not  in  fact  usually  followed. 

Another  question  presents  itself.  Might  not  our  exporter 
quote  his  price  in  dollars  and  draw  nevertheless  in  milreis? 
Might  he  not  draw  for  a  sufficient  sum  of  milreis  to  enable 
the  draft  to  be  sold  to  a  bank  for  the  number  of  dollars 
due  him  ?  The  difficulty  is  that  the  banks  would  not  care  to 
purchase  such  a  draft  at  any  figure  which  would  make  its 
use  worth  while.  The  purchasing  bank  would  then  be 
taking  a  greater  risk  of  exchange  than  it  cares  to.  The 
methods  of  settlement  with  Brazil  may  change  in  the  course 
of  time  if  Brazil  ultimately  takes  steps  to  assure  the  stability 
of  her  exchange  rate  on  New  York.  Absolute  stability  is 
not  to  be  expected,  but  measures  might  be  put  in  effect  to 
limit  fluctuations  somewhat  narrowly. 

The  exchange  rates  of  Brazil  on  gold  standard  countries 
have  been  much  more  stable  in  recent  years  than  in  earlier 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      281 

times,  the  government  of  the  country  having  made  certain 
partially  successful  efforts  to  establish  a  gold-exchange 
standard.  In  1896  the  highest  (i.e.,  dearest)  rate  in  Rio 
on  London  was  72%2  pence  (November  11th)  and  the  low- 
est (i.e.,  cheapest)  rate  was  lO11/^  pence  (June  3d).  The 
difference  between  these  two  rates  is  about  23%  of  their 
average.  This  was  17  times  greater  than  the  maximum 
variation  in  New  York  rates  on  London  for  the  same  year. 
The  greatest  variation  of  rates  in  Rio  within  a  period  of 
two  weeks  in  the  3rear  1896,  took  place  between  the  6th  and 
20th  of  May,  and  was  one  of  8.6%.  This  is  practically 
eight  times  as  great  a  fluctuation  as  can  possibly  take  place 
in  any  length  of  time  in  New  York  rates  on  London  if 
the  banks  in  both  the  United  States  and  England  are 
actually  paying  gold  without  premium  and  if  gold  can  be 
freely  transported,  assumptions  which  have  not  held  good 
during  the  present  world  war. 

Brazil  has  been  used  merely  as  an  illustration  of  a  country 
upon  which  the  type  of  exchange  we  are  discussing  is  drawn. 
If  an  exporter  of  the  United  States  ships  to  any  part  of 
South  America  or  to  most  parts  of  the  Far  East,  and  settle- 
ment is  effected  by  draft  on  the  importer,  the  draft  is 
almost  certain  to  be  drawn  for  dollars.  But  the  custom 
of  drawing  foreign  bills  for  home  money  is  not  confined 
to  this  country  nor  did  it  originate  here.  It  is  followed 
in  a  number  of  the  great  commercial  countries,  but  presum- 
ably first  arose  in  England  where  exporters  have  for  many 
years  made  a  practice  of  drawing  on  foreign  lands  in 
pounds.  As  early  as  1854  we  find  the  London  Economist 
advising  British  traders  to  draw  on  Russia  in  sterling  be- 
cause of  the  issue  of  inconvertible  paper  by  that  country 
in  connection  with  the  Crimean  War,  and  the  consequent 
expectation  of  instability  in  its  exchanges.3 

s  Mentioned  in  Clare's  "A  B  C  of  the  Foreign  Exchanges,"  p.  65, 
note. 


282  FOREIGN  EXCHANGE 

§  70.  The  banker's  buying  price  for  such  a  bill. — Tn  nam- 
ing a  buying  price  for  the  bill  considered  in  the  preceding 
section,  the  bank  does  not  (/note  a  rate  of  exchange.  It 
docs  not  buy  an  instrument  payable  in  a  fixed  sum  of  for- 
eign money  but  one  promising  to  return  a  predetermined 
amount  of  home  money.  It  pays  dollars  and  gets  back  a 
foreknown  sum  of  the  same  dollars.4  It  does  not  buy  one 
kind  of  currency  for  another  and  foreign  kind.  It  should 
be  noted  that  the  amount  for  which  the  bill  is  drawn  is 
not  the  datum  from  which  its  price  is  calculated,  but  re- 
versely the  price  is  first  known  and  the  amount  for  which 
it  is  to  be  drawn  is  computed  from  this  datum.  That  is, 
continuing  the  illustration  of  the  preceding  section,  the 
drawer  is  first  of  all  entitled  to  receive  $8,000  and  the 
question  becomes,  how  large  is  the  sum  of  dollars  for  which 
the  bill  must  be  drawn  to  make  it  worth  $8,000  to  the 
banker  as  purchaser.     The  answer  is  $8206.66. 

Interest  and  commission  are  the  factors  in  the  computa- 
tion. The  banker  pays  dollars  in  advance  and  awaits  the 
return  draft  for  dollars.  In  this  class  of  operations  6% 
is  the  customary  rate  of  interest  charged  (without  regard 
to  the  current  money  market)  for  the  period  expected  to 
elapse  before  the  return  draft  will  arrive.  The  charge  for 
commission  we  may  assume  to  be  34  of  1%. 

The  computation  takes  the  following  form: 

Draft  on  Rio  at  90  days'  sight. 

Banker's  buying  price  for  the  bill $8,000.00 

Banker's  interest  charge  on  this  for  140  days  at  6%        186.66 

Commission    20.00 

Vi  of  1%  of  $8,000  =  $20. 

Total  required  return $8,206.66 

Thus  the  bill  will  have  to  be  drawn  for  $8206.66,  and  the 
4  Assuming  of  course  that  the  bill  is  honored. 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      283 

Brazilian  drawee  will  have  to  pay  a  sufficient  sum  of  niilreis 
to  purchase  a  sight  draft  on  New  York  for  this  number 
of  dollars.  The  importer  will  be  able  to  take  possession 
of  the  goods  on  their  arrival  because  in  the  case  of  exports 
to  South  America  custom  requires  the  instructions,  "docu- 
ments for  acceptance."  Prepayment  of  the  draft  with  a 
rebate  of  interest  is  thus  unnecessary. 

The  banker's  account  with  this  operation  will  stand  as 
follows : 

Outlay    $8,000.00 

Return,  after  140  days  8,206.66 

Excess  of  return 206.66 

This  consists  of 

Commission    20.00 

Interest    on    $8,000    for  .140    days    at 
6%  p.a 186.66 

Total    206.66 

In  the  preceding  calculation  it  has  been  assumed  that 
the  banker  is  willing  to  purchase  the  exporter's  bill  on  the 
basis  of  6%  interest  rate,  that  is  to  purchase  it  at  a  price 
which  yields  him  6%  interest  on  his  advance  for  the  as- 
sumed term  of  the  advance.  If,  however,  the  6%  rate 
quoted  is  a  discount  rate,  as  is  sometimes  the  case,  the 
bill  as  drawn  will  not  sell  for  quite  the  full  $8,000  due 
the  drawer,  but  will  fetch  a  price  computed  as  follows : 

Future  sum,  or  returns  from  the  bill,  140  days  deferred  $8,206.66 

140  days'  discount  on  this  sum  at  6%  per  annum 191.49 

(14%oo  of  6%  of  $8,206.66  =  $191.49) 

Gross  price  of  bill   8,015.17 

Commission  due  banker   20.00 

Net  price  received  by  drawer $7,995.17 


284  FOREIGN  EXCHANGE 

To  avoid  the  loss  of  $4.83  hero  entailed,  the  exporter  may 
draw  the  bill  for  a  sufficient  sum  of  dollars  to  make  il 
yield  $8,000  when  discounted  at  6%.  The  method  of  figur- 
ing the  amount  for  which  he  must  draw  in  this  case,  is 
shown  beneath. 

14%co  of  6%,  or  the  percentage  of  discount  for  140  days  =  21,£% 
The  price  of  the  hill  will  therefore  be  100%  —  2%%  of 

the  face  value  or  amount  drawn  for,  or 97%% 

Since  the  price  of  the  bill  including  commission  is  to  be 

$8,020,  $8,020  must  be  97%%   of  the  amount  drawn 

for. 
The  amount  drawn  for  must  therefore  be $8,211.60 

(Divide  $8,020   by  97%%   to  find  1%   and  multiply 
by  100) 
This  is  the  amount,  of  which  97%%  is  just  $8,020.00.     To  com- 
plete the  account : 

Discounted  present  price  of  the  bill $8,020.00 

Commission  paid  banker   20.00 

Net  cash  proceeds  from  sale  of  bill $8,000.00  5 

§  71.  The  bill  on  a  foreign  country  in  money  of  a  third 
country. — 

Sub-sec.  1.  A  Third  Type  of  Draft  of  the  Importer. 
— Thus  far  we  have  familiarized  ourselves  with  two  classes 
of  drafts  on  importers,  distinguishing  them  in  accordance 
with  the  kind  of  money  in  which  they  are  drawn,  namely 
drafts. 

5  Compare  §  14  on  the  distinction  between  an  interest  and  a  dis- 
count rate.  The  computation  as  given  assumes  that  the  banker  will 
collect  his  commission  of  $20  in  advance  (just  as,  by  exacting  dis- 
count, he  virtually  takes  interest  "in  advance").  If  it  is  desired  to 
calculate  the  amount  to  be  drawn  for  on  the  assumption  that  the 
banker  takes  his  commission  140  days  later  or  from  the  returns,  it 
will  be  necessary  to  find  the  amount  which  being  discounted  for  140 
days  at  6%  per  annum  will  yield  $8,000  present  cash,  and  to  add  to 
this  $20.     The  answer  would  be  $8,211.12. 


DEALINGS  OP  A  MORE  INVOLVED  CHARACTER      285 

(1)  for  the  money  of  the  importer's  country,  and 

(2)  for  the  money  of  the  exporter's  country. 
It  remains  to  examine  the  draft 

(3)  for  the  money  of  a  third  country. 

Bills  on  the  Far  East  and  on  the  various  countries  of 
Latin  America  drawn  in  pounds  sterling,  but  originating 
in  some  country  distinct  from  England,  stand  forth  as 
the  chief  practical  examples  of  this  form  of  exchange.  If 
a  bill  is  drawn  for  money  of  a  third  country,  it  is  almost 
certain  to  be  for  money  of  England,  whether  or  not  this 
will  always  continue  the  case. 

Let  us  suppose  Smith  of  New  York  ships  hardware  to 
Lopez  of  Buenos  Aires,  on  the  understanding  that  as  ex- 
porter he  is  to  receive  $7,200  in  money  of  the  United  States 
on  the  date  of  shipment,  to  be  obtained  by  the  sale  of  his 
bill  on  Lopez  drawn  for  a  sum  of  pounds  sterling.  The 
face  value  in  sterling  will  then  need  to  be  high  enough 
to  enable  the  sale  of  the  bill  for  $7,200  in  New  York  on  the 
date  when  it  is  drawn.  Whereas  a  dollar  draft  on  Buenos 
Aires  would  be  dischargeable  by  the  purchase  and  return  of 
a  bill  on  New  York  for  dollars,  a  sterling  draft  on  the 
same  city  is  paid  off  by  the  purchase  and  return  (either 
to  New  York  or  to  London  on  instructions  from  New  York) 
of  a  bill  on  London  for  pounds.  The  ' '  return ' '  bill,  as  we 
shall  continue  to  call  it,  will  be  according  to  custom  at  sight 
when  it  is  on  New  York,  but  at  90  days'  sight  when  it  is  on 
London,  not  that  return  bills  G  of  other  lengths  of  life  are 
out  of  the  question.7 

6  As  stated  on  an  earlier  page,  we  have  now  (1919)  in  the 
United  States  practically  discontinued  drawing  this  type  of  bill.  The 
war-time  fluctuations  of  the  value  of  the  pound  sterling  in  terms 
of  the  American  dollar,  is  of  course  the  explanation.  Some  of  our 
bankers  believe  this  instrument  will  never  come  back  into  our  trade 
even  when  the  pound  sterling  of  actual  currency  becomes  a  gold  unit 
again.     Cf.  Addendum  infra  on  dollar  exchange. 

7  Drafts  from  the  United  States  on  Australasia  for  sterling  have 


286  FOREIGN  EXCHANGE 

The  draft  of  Smith  on  Lopez  will  take  on  some  form 
similar  to  the  following: 

£1,541  5s.  Od.  New  York,  N.  Y.,  July  1st,  1913. 

Ninety  days  after  sight  of  this  first  of  exchange  (second  un- 
paid) pay  to  the  order  of  the  South  American  Banking  Corpora- 
tion, One  Thousand  Five  Hundred  and  Forty-one  Pounds  and 
Five  Shillings,  payable  in  legal  currency  at  the  hank's  drawing 
rate  on  day  of  payment  for  ninety  days'  sight  bills  on  London. 
Value  received  per  S.S.  Southern  Star. 

William  N.  Smith. 
To  Alfredo  Lopez, 

Calle  Corrientes,  1550. 

Buenos  Aires,  Rep.  Arg. 

Sub-Sec.  2.  The  Three  National  Currencies  In- 
volved.— Although  a  certain  number  of  dollars  are  due 
and  will  actually  be  received  by  the  drawer  of  this  draft, 
and  pesos  will  be  the  money  actually  paid  over  by  the 
drawee  to  discharge  it,  the  only  sum  specified  in  the  instru- 
ment is  a  number  of  pounds  sterling.  Three  distinct  na- 
tional currencies  are  then  involved.  As  for  the  relations 
among  them:  the  number  of  dollars  due  the  exporter  (in 
conjunction  with  a  rate  of  exchange)  determines  the  amount 
of  sterling  drawn  for,  and  the  latter  in  turn  (in  conjunc- 
tion with  another  rate  of  exchange)  determines  the  num- 
ber of  pesos  required  to  pay  off  the  draft. 

Assume  that  the  bill  set  forth  above  is  sold  on  July 
1st  to  the  New  York  office  of  the  South  American  Bank- 
ing Corporation  for  $7,200.  The  receipt  of  this  sum  pays 
the  exporter  for  his  goods.  The  New  York  office  of  the 
bank  named  now  forwards  the  instrument  to  the  branch  at 
Buenos  Aires,  whose  province  it  will  be  to  present  the  same 
for    acceptance    and   subsequently    for    payment.     Ninety 

been  customarily  drawn  at  sight  and  have  also  called  for  the  return 
sterling  bill  at  sight. 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      287 

days  after  the  date  of  acceptance  (there  being  no  days  of 
grace  in  Latin- American  countries)  the  drawee  will  be 
obligated  to  pay  over  a  sufficient  sum  of  pesos  to  buy  at  the 
selling  (or  "drawing")  rate  then  being  quoted  by  the 
South  American  Banking  Corporation  in  Buenos  Aires,  a 
90  days '  sight  draft  on  London  for  £1,541  5s.  In  substance, 
he  will  purchase  a  draft  drawn  by  this  bank  on  a  London 
bank,  but  will  turn  it  back  to  this  institution  as  holder  of 
his  acceptance  and  in  discharge  of  the  same.  If  the  rate 
for  this  draft  proves  to  be  48d.  (namely,  48d.  of  sterling 
to  one  peso)  it  will  cost  the  importer  7706.25  pesos,  sig- 
nifying pesos  of  gold.  There  is  also  in  the  Argentine  a 
national  legal  tender  paper  money.  Assuming  this  to  be 
at  its  official  redemption  value  in  gold  (one  peso  of  paper 
to  4}ioo  of  a  peso  gold),  17493.19  pesos  of  paper  would  be 
required. 

Sub-Sec.  3.  The  Disposal  of  the  Return  Draft. — 
The  return  draft  now  belongs  to  the  New  York  office  of  the 
South  American  Banking  Corporation,  inasmuch  as  this 
office  paid  for  the  original  bill  drawn  by  the  exporter.  It 
must  be  admitted  that  this  draft  can  under  certain  circum- 
stances be  eliminated,  to  be  replaced  by  mere  book  entries 
at  the  branches  supplemented  by  interchange  of  advices, 
but  we  had  better  complete  our  illustration  on  the  assump- 
tion that  it  is  actually  drawn  and  mailed,  as  it  would  be 
were  there,  for  instance,  three  independent  banks  at  the 
three  main  points  involved.  The  best  disposition  of  this 
instrument  the  New  York  office  can  order  is  its  remittance 
directly  to  London  for  its  account  or  credit  with  some  bank- 
ing establishment  there.  This  saves  the  time  that  would 
be  lost  by  having  it  go  to  London  by  way  of  Now  York, 
and  will  enable  its  acceptance  and  consequently  its  maturity 
to  occur  at  the  earliest  possible  dates.8     The  New   York 

s  If  a  South  American  banker  who  holds  a  loii^'  sterling  bill  for  a 
New  York  bank,  is  requested  to  forward  the   instrument   directly  to 


FOREIGN  EXCHANGE 

banker  will  ordinarily  haw  the  draft  discounted  in  London 

On  its  arrival,  and  may,  about  six  days  earlier,  sell  sight 
sterling  in  New  York  againsl  the  proceeds  of  the  same  as 
cover.  In  analyzing  the  whole  operation  before  us,  we 
assume  this  sale  to  be  made,  for  it  is  solely  on  this  assump- 
tion that  we  can  compute  the  bank's  gain.  "When  it  buys 
the  exporter's  original  draft,  it  makes  an  outlay  of  dollars 
to  obtain  a  deferred  return  of  sterling  in  London.  The 
dollar  worth  of  this  sterling  must  always  be  counted  as  the 
sum  it  will  fetch  when  sold  out  as  promptly  as  possible 
as  exchange  on  the  New  York  market.  By  means  of  such 
a  sale  the  New  York  banker  finally  recovers  the  dollar 
fund  first  laid  out,  normalh/  with  a  sufficient  increment  to 
cover  interest  and  a  commission  or  profit. 

Sub-Sec.  4.  The  Risks  of  Exchange  and  Their  Inci- 
dence.— The  owner  of  the  original  exporter's  draft  (the 
bank  in  New  York,  if  it  buys  the  draft,  the  exporter  him- 
self, if  the  bank  receives  it  merely  for  collection)  takes  a 
risk  of  exchange.  For  at  the  time  this  instrument  is  drawn 
the  outcome  in  dollars  from  the  sterling  exchange  return- 
able from  Buenos  Aires  cannot  be  precisely  foretold.  The 
chance  thus  taken  is  called  a  "risk  of  exchange"  because 
the  outcome  will  depend  on  a  rate  of  exchange,  namely  the 
rate  for  sterling  in  New  York  on  the  day  of  the  sale  of 
the  sight  sterling  draft  in  that  city  against  the  arrival  of 

London,  he  makes  it  payable  to  and  mails  it  to  the  New  York  bank's 
London  correspondent,  accompanied  by  the  advice  that  it  is  for  the 
account  of  the  New  York  bank.  The  bill  cannot  be  drawn  or  indorsed 
payable  to  the  New  York  banker,  because  it  would  then  require 
his  indorsement,  whereas  it  is  not  to  go  through  his  hands.  The 
London  correspondent  will  indorse  it  and  dispose  of  it  according  to 
instructions  from  New  York.  This  will  make  the  London  correspon- 
dent liable  as  an  indorser.  It  is  understood  that  if  this  liability 
should  ever  cost  it  anything,  it  would  look  to  the  New  York  banker 
for  reimbursement  since  it  indorsed  for  his  sake  and  as  his  virtual 
agent. 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      289 

the  return  bill  in  London.  (The  outcome  will,  under  the 
conditions  of  our  illustration,  depend  also  in  part  upon  the 
money  rate  ruling  in  London  on  the  day  of  the  discount 
of  the  return  bill  in  that  city.  If  the  latter  could  with 
advantage  be  mailed  from  Buenos  Aires  to  New  York  to  be 
sold  as  long  sterling  at  that  point,  the  outcome  would  then, 
of  course,  depend  merely  upon  the  long  sterling  rate  pre- 
vailing then  and  there,  but  this  would  in  turn  be  governed 
in  part  by  the  London  discount  rate.) 

But  the  risk  of  exchange  taken  by  the  exporter  or  banker 
of  New  York  is  merely  one  as  to  the  rates  for  sterling  in 
New  York.  Neither  will  have  concern  with  any  fluctuations 
which  may  take  place  in  the  rate  for  sterling  in  Argentina. 
The  more  hazardous  risk  of  exchange  resident  in  these 
fluctuations,  is  carried  solely  by  the  importer  in  Argentina. 

When  after  the  inception  of  the  present  great  war,  rates 
for  sterling  exchange  fell  away  in  New  York,  outstanding 
sterling  drafts  on  South  America  began  to  bring  in  very 
disappointing  returns  in  dollars.  The  considerable  period 
to  run  between  the  inception  and  the  settlement  of  opera- 
tions naturally  increased  the  difficulty,  and  there  were 
forced  upon  either  the  drawers  or  the  bankers,  as  the  case 
might  be,  certain  most  annoying  losses.  (A  banker  pur- 
chasing such  a  bill  may  make  a  special  contract  forcing 
the  risk  of  exchange  back  onto  the  drawer  or  exporter.) 
Prior  to  the  war  the  risk  of  exchange  involved  in  the 
handling  of  these  bills  was  not  excessive.  Also  practical 
compensation  for  carrying  it  was  secured  in  a  somewhat 
hidden  manner  by  means  of  a  rather  liberal  method  of 
figuring  the  amount  of  sterling  to  be  drawn  for. 

Shb-Sec.  5.  Computing  the  Sterling  Pace  Value. — 
To  determine  the  amount  of  sterling  for  which  he  must 
draw,  it  would  be  natural  to  suppose  the  exporter  would 
ascertain  from  the  bank  its  buying  rate  in  dollars  per 
pound  for  such  a  draft  as  he   proposed   to   offer.     Prom 


290  FOREIGN  EXCHANGE 

this  he  might  compute  the  pounds  of  face  value  necessary 
to  yield  the  number  of  dollars  due  him.  Tims  should 
the  banker's  rate  be  $4.67' i  per  pound,  the  draft  would 
have  to  be  drawn  for  £1540.93  (or  £1,540  18s.  7d.)  in  order 
to  fetch  $7,200.  Under  this  plan,  the  exporter  would 
in  effect  make  the  following  statement  to  the  importer: 
"I  have  this  day  drawn  upon  you  at  90  days'  sight  a  bill 
which  you  can  discharge  at  its  maturity  by  the  purchase  of 
a  90  days'  sight  draft  on  London  for  £1,540  18s.  7d.  I  am 
entitled  to  receive  $7,200  to-day  and  since  the  banker  at 
this  place  offers  $4.6714  per  pound  for  my  bill  I  must  neces- 
sarily draw  for  the  number  of  pounds  above  mentioned. 
7,200  -=-  4.6725  =  £1540.93. ' ' 

But  this,  the  simplest  method  of  computing  sterling  face 
value  that  could  be  followed,  is  not  the  one  that  has  been 
actually  customary.  Before  the  present  time  banks  of  Brit- 
ish origin  have  handled  most  of  the  bills  drawn  in  this 
country  upon  South  America,  and  it  has  been  the  practice 
in  dealing  with  these  banks  for  our  exporter  to  add  in- 
terest and  banker's  commission  to  the  dollars  that  are  due 
him  as  of  the  date  of  shipment,  and  convert  the  total  into 
sterling  at  a  fixed  and  customary  rate  depending  upon  the 
term  or  usance  of  the  return  sterling  draft.  "With  the 
latter  at  90  days'  sight,  the  regular  rate  of  conversion  was 
(prior  to  the  present  war)  $4.80  per  pound:  with  it  at 
sight,  this  rate  was  $4.85,  but  these  particular  rates  have 
of  course  all  gone  by  the  board  since  the  outbreak  of  the 
war.9  At  the  end  of  1918,  a  conversion  rate  of  4.75  was 
being  employed  in  certain  trades  for  return  sterling  drafts 
drawn  at  sight. 

Smith's  bill  on  Lopez,  as  given  at  the  beginning  of  this 
section,  is  drawn  for  £1,541  5s.  Od.  This  sum  is  computed 
according  to  what  has  just  been  explained  as  the  customary 

9  The  rate  of  conversion  has  been  fixed  or  invariable  except  for  mo- 
mentous alterations  of  exchange  conditions. 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      291 

method.  To  the  number  of  dollars  due  Smith  on  the  day 
of  shipment,  namely  $7,200,  is  added  interest  at  6%  per 
annum  for  150  days,  and  banker's  commission  at  Vi  of  1%. 
The  total  thus  obtained,  still  a  sum  of  dollars,  is  "con- 
verted" (i.e.,  translated)  into  sterling  at  the  rate  of  $4.80 
to  the  pound.  The  amount  of  sterling  so  computed,  is 
the  face  value  of  Smith's  draft  on  Lopez,  and  is  the  face 
value  of  the  90  days'  banker's  draft  on  London  which  Lopez 
is  required  to  provide  for  return  to  Smith  or  his  successor 
in  ownership  of  the  original  draft.  Smith's  computation 
takes  the  form  shown  beneath : 

Invoice   cost   of  goods   including   all   charges   due   ex- 
porter.    Due  in  New  York  on  July  1st $7,200.00 

Interest  on  the  above  for  150  days  at  6%  per  annum.  .        180.00 
6%  per  annum  is  the  rate  of  interest  customary  in 

settlements  of  this  kind. 
The  period   of   150   days   consists   in   the   following 
allowances  for  elapsed  time: 

a.  Mail  to  Buenos  Aires 30  days 

b.  Term  from  acceptances  till  payment  of 

exporter's  draft  90  days 

c.  Return  mail  to  New  York 30  days 

Total    150  days 

Banker's  commission  for  handling  draft,  at  \i% 18.00 

Total  dollar  return   required  in   New  York   after  the 

expiry  of  150  days  $7,398.00 

Number  of  pounds  face  value  of  return  sterling  bill 

therefore  required,  at  rate  £1  =  $4.80 £1,54B4 

I.e.,  7,398  -4-  4.80  =  1,514%. 

The  assumptions  underlying  this  calculation  are  (1)  that 
150  days  will  elapse  between  the  drawing  of  the  original 
draft  and  the  realization  or  recovery  of  dollars  in  New 
York  from  the  return  sterling  bill,  and  (2)  that  the  amount 


292  FOREIGN  EXCHANGE 

realized  from  each  pound  of  this  return  bill  will  be  $4.80. 
It  happens,  as  already  explained,  that  if  Smith's  original 
draft  is  sold  to  a  banker  the  return  bill  will  not  in  fact 
come  to  New  York,  but  will  be  forwarded  from  Buenos 
Aires  direct  to  London,  for  the  purpose  of  saving  time ; 
but  to  make  as  clear  as  possible  the  customary  computation, 
with  which  we  are  now  concerned,  let  us  suppose  for  the 
moment  that  the  return  bill  is  sent  to  New  York.  If  upon 
its  arrival  it  could  be  sold  in  the  exchange  market  for 
$4.80  per  pound,  it  would  yield  just  $7,398.  Thus  it  would 
be  the  equivalent  of  a  New  York  check  for  this  sum,  and 
this  sum  includes  the  $7,200  due  as  of  the  date  of  July 
1st,  plus  $180  for  interest  and  $18  for  banker's  commission. 
Sub-Sec.  6.  Comparison  With  a  More  Familiar 
Method  of  Settlement. — It  will  be  useful  to  compare  this 
method  of  settlement  with  a  simpler  and  more  familiar 
but  essentially  similar  one.  A  buyer  in  Denver  of  goods 
from  New  Orleans  might  make  payment  to  the  shipper 
by  remitting  a  banker's  sight  draft  on  New  York.  The 
shipper  would  "cash"  this  in  New  Orleans.  In  other 
words,  he  would  sell  this  New  York  exchange  for  money  of 
New  Orleans.  Now  the  case  is  not  so  dissimilar  if  an  im- 
porter in  Buenos  Aires  makes  payment  to  the  exporter  at 
New  York  by  remitting  a  banker's  draft  on  London,  to  be 
sold  for  local  money  of  New  York.  It  is  true  certain  com- 
plications in  detail  appear  in  the  foreign  transaction.  The 
New  York  exporter  draws  on  the  Argentine  merchant  a 
draft  which  specifically  calls  for  the  return  sterling  bill. 
The  shipper  at  New  Orleans  may  not  draw  on  the  Denver 
buyer  at  all,  being  content  merely  to  render  him  a  state- 
ment of  account  and  expect  him  to  make  a  remittance  in 
some  suitable  form  of  domestic  exchange.  But  if  the  do- 
mestic shipper  did  draw,  the  draft  would  in  all  probability 
be  one  for  dollars  merely  and  not  one  for  a  specified  kind 
of  return  exchange.     That  is  to  say,  a  draft  in  the  special 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      293 

form  of  one  payable  in  exchange  or  of  one  calling  for  a 
return  bill  of  exchange  of  a  stipulated  character,  is  ex- 
ceedingly uncommon  in  domestic  practice.  Under  our 
past  custom  the  domestic  shipper  would  not  draw  a  long- 
term  draft,  but  rather  one  at  sight  or  perhaps  three  days' 
sight,  while  the  exporter  to  foreign  parts  will  as  a  rule 
draw  a  long-term  bill.  However,  it  is  very  probable  that 
the  long-term  draft  on  the  domestic  mercantile  debtor  is 
about  to  play  a  role  of  increasing  significance  in  our  internal 
commerce,  this  development  being  especially  favored  by 
the  recent  important  changes  in  our  banking  system.  In 
the  particular  foreign  illustration  before  us,  the  return, 
bill  remitted  to  the  exporter  (or  to  the  banker  who  suc- 
ceeds to  him  or  to  this  banker's  correspondent  in  London, 
as  the  case  may  be),  is  itself  a  long  bill.  Such  a  form  of 
remittance  finds  no  counterpart  in  our  purely  domestic 
commerce  to-day.  Comparison  might  be  carried  further, 
but  enough  has  been  said  to  show  that  our  settlements  by 
sterling  drafts  on  South  America  are  not  so  complex  as 
perhaps  the}'  seemed  at  first.  "When  our  exporter  converts 
or  translates  his  invoice  puis  interest  and  banker's  com- 
mission, into  sterling  at  the  rate  of  £1  =  $4.80,  it  is  merely 
tantamount  to  counting  £1  of  90  days'  sight  draft  on  Lon- 
don as  the  equivalent  of  a  New  York  check  for  $4.80,  on  the 
theory  that  $4.80  can  be  realized  from  the  said  £1  of  ex- 
change. 

Sub-Sec.  7.  The  Outcome  to  the  Purchasing  Banker. 
— Let  us  assume  that  Smith's  personal  standing  being  sat- 
isfactory, he  is  able  to  sell  his  bill  to  the  banker  in  New 
York  for  $7,200,  the  amount  due  Smith  as  exporter  if  he 
receives  paj'ment  on  the  day  of  shipment.  How  will  the 
banker  fare  as  purchaser?  Suppose  first,  for  the  sake  of 
simplicity,  that  the  return  sterling  draft  is  ordered  sent 
to  New  York,  and  that  150  days  elapse  before  its  arrival, 
and  that  it  is  then  sold  in  New  York  for  $4.80  per  pound. 


294  KOKKKiX    KXCIIAXCK 

The   banker's  account  with   the  operation  would   assume 
this  form : 

Outlay   for  the  bill $7,200.00 

Return  from  the  same,  150  days  later 7,398.00 

Procured  by  the  sale  of  £1,541%  of  90  days  sterling 
at  $4.80  per  pound. 

Excess  of  return  over  outlay 198.00 

Being  made  up  of 

Commission  at  Vi%  on  $7,200 $  18.00 

Interest  on  $7,200  for  150  days  at  6% 

per  annum   180.00 


198.00 


Here  the  bank  makes  its  commission  and  interest  at  6% 
per  annum. 

But  the  banker  can  put  forward  the  recovery  of  dollars 
by  about  a  week  (in  the  instance  before  us)  by  having  the 
return  sterling  bill  forwarded  direct  from  Buenos  Aires 
to  his  correspondent  in  London.  This  alone  will  make  the 
operation  yield  a  better  interest  rate  than  the  one  shown 
in  the  foregoing  statement.  Again,  the  banker  may  be 
able  to  realize  more  than  $4.80  from  each  pound  of  the 
return  draft.  If  we  assume  an  extremely  favorable  out- 
come, we  might  be  able  to  make  up  a  statement  somewhat 
on  the  lines  of  the  following: 

Outlay  to  purchase  exporter's  bill  on  July  1st $7,200.00 

Actual  time  elapsed  before  recovery  of  dollars 

in  New  York 134  days 

The  original  bill  reaches  Buenos  Aires  25  days 
after  July  1st,  is  paid  90  days  later,  and  the  long 
sterling  bill  sent  directly  to  London  reached  there 
25  days  later  yet.     Total  time  to  London,  140  days. 

The  return  sterling  draft  arrives  in  London,  there- 
fore, on  November  18th.  It  is  immediately  dis- 
counted   there    on    orders    given    in    advance.     This 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      295 

enables  a  sale  of  sight  bills  on  London  in  New  York 
6  days  earlier,  on  November  12th.  These  are  for 
the  amount  of  cash  sterling  received  from  the  dis- 
count. 

Total  elapsed  time  till  recovery  of  dollars,  134  days. 
Dollars  recovered  per  pound  of  draft 4.8330 

If  the  London  discount  rate  is  3%  and  the  sight 
sterling  rate  in  New  York  on  November  12th  is 
4.87,  the  banker  will  be  able  to  realize  about  $4.8330 
for  each  pound  of  draft  discounted  in  London.  (Cf. 
§  64  for  method  of  computing  this.) 

Total  dollars  actually  recovered  by  banker $7,448.86 

4.8330  X  1541%  (pounds  face  value  of 
draft)  =7448.86 

Gain  by  banker  $    228.86 

Composed  of  the  following  elements: 

Commission  at  %%    $  18.00 

Interest  at  $7,200  for  134  days  at  6% 158.60 

Gain  in  excess  of  6%  interest 52.26 

Total    288.86 

Stated  in  another  way,  the  banker  makes  interest  at  8% 
per  annum  in  addition  to  his  commission,  but  this  is  vir- 
tually the  most  favorable  case  possible.  Mails  may  be  slow. 
Acceptance  may  be  delayed  (especially  in  South  America) 
till  the  merchandise  arrives,  perhaps  by  a  slow  steamer. 
The  customary  assumptions  as  to  the  time  to  elapse  and 
the  dollar  value  of  the  return  sterling  draft,  must  be  suffi- 
ciently liberal  to  provide  against  losses  in  the  general  run 
of  cases,  though  they  are  doubtless  hardly  liberal  enough 
to  afford  full  protection  in  a  few  of  the  worst  cases  actually 
experienced.10 

io  As  already  stated,  heavy  losses  were  experienced  by  the  buyers 
of  these  bills  at  the  time  of  the  great  fall  of  sterling  in  New  York 
not  long  after  the  beginning  of  the  great  war. 


296  FOKKKiN    KXC'HANOK 

Sub-Sec.  8.  Special  Contracts  With  Respect  to  the 
RlSK  OF  EXCHANGE. — The  exporter,  in  the  illustration  be- 
fore us,  calculated  the  sterling  face  value  of  his  draft  on 
the  assumption  that  eaeh  pound  drawn  for  would  in  the 
end  yield  +4.80.  The  banker  paid  $7,200  for  the  draft  on 
the  same  assumption.  Sometimes  the  banker  requires  the 
exporter  to  make  a  special  contract  promising  to  indem- 
nify him,  the  banker,  for  any  loss  sustained  through  his 
inability  in  fact  to  realize  $4.80  per  pound.  This  contract 
has  the  effect  of  throwing  upon  the  exporter  any  unfavor- 
able risk  of  exchange  involved  in  the  purchase  of  his  draft 
(see  prior  discussion).  On  the  other  hand,  if  the  risk 
turns  out  favorably,  that  is,  if  each  pound  yields  more  than 
$4.80,  the  gain  will  belong  to  the  banker  unless  the  special 
contract  provides  that  it  go  to  the  exporter.  It  would  be 
possible  to  have  a  special  agreement  providing  for  the  com- 
pensation of  the  banker  for  loss  because  of  a  failure  of  the 
returns  to  arrive  within  the  period  of  150  days  assumed,  but 
if  the  purchase  of  the  exporter's  draft  by  the  banker  should 
be  cluttered  with  so  much  incidental  protection,  it  would 
virtually  come  to  a  taking  of  the  draft  for  collection  coupled 
with  a  100%  advance  against  it  as  collateral. 

Sub-Sec.  9.  The  Importer's  Preference  for  the  Cus- 
tomary Reckoning. — The  actual  elapsed  time  and  actual 
dollar  yield  of  the  return  draft  are  variables  depending 
upon  the  circumstances  of  each  individual  case.  They  can- 
not be  determined  precisely  in  advance,  and  under  the  cus- 
tomary method  there  is  no  attempt  to  make  a  special  esti- 
mate of  these  factors  for  each  separate  case.  It  is  very 
convenient  to  assume  fixed  figures  which  are  to  be  used  in 
all  ordinary  instances.  If  special  figures  were  to  be  adopted 
for  each  separate  export,  the  importer  would  either  have 
to  be  informed  of  them  and  given  an  opportunity  to  concur 
in  them,  which  would  be  impracticable  by  mail,  or  he  would 
have  to  submit  to  their  determination  by  the  exporter  or 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      297 

the  banker,  neither  of  whom  have  interests  in  the  matter 
identical  with  his.  So,  as  we  are  given  to  understand,  he 
prefers  to  have  the  dollar  charges  against  him  converted 
or  translated  into  sterling  at  a  customary  rate  and  to  have 
the  interest  figured  at  a  fixed  rate  under  the  assumption 
of  a  fixed  period  for  completion  of  the  settlement.  This 
enables  him  to  calculate  in  advance  with  perfect  definite- 
ness  the  amount  of  sterling  he  will  be  expected  to  provide 
against  a  given  dollar  cost  for  goods,  and  leaves  him  with 
but  one  uncertain  factor,  namely  the  rate  for  sterling  in  his 
own  city  at  the  time  when  he  comes  to  make  payment. 
The  problem  of  establishing  the  customary  figures  is  one  of 
making  them  sufficiently  liberal  from  the  point  of  view  of 
the  exporter  and  the  banker  who  buys  his  draft,  without 
making  them  unfair  to  the  importer.  If,  for  example, 
speaking  of  ante-bellum  conditions,  it  were  to  be  assumed 
in  the  case  before  us  that  200  days  would  be  the  elapsed 
time  and  that  $4.76  would  be  the  dollar  yield  of  each  pound 
of  the  return  draft,  there  would  be  an  increased  margin 
of  safety  for  the  benefit  of  the  drawer  and  purchasing 
banker,  but  the  assumptions  would  evidently  be  unfair  to 
the  importer.  The  assumptions  that  had  in  fact  become  cus- 
tomary or  standardized  before  the  war  were  known  to  the 
importers  of  South  America  and  were  acquiesced  in  by 
them,  and  according  to  Mr.  Fred  C.  Harding,  of  the 
Anglo  South  American  Bank,  Ltd.,  these  merchants  did 
not  take  kindly  to  the  adoption  by  our  exporters  of 
other  methods  of  computation,  even  if  they  turned  out 
quite  as  favorably  to  the  importer  as  the  customary.11 

Sub-Sec.  10.  Purchasing  the  Draft  on  the  Basis  op  a 
Discount  Rate. — It  has  been  assumed  up  to  this  point  that 
the  banker  buys  the  exporter's  draft  on  the  basis  of  a  6% 
interest  rate,  or  at  a  price  calculated  to  yield  him  6% 

n  See  his  article  on  the  Financing  of  Exports  in  the  "Exporters' 
Encyclopedia"  for  1014,  pp.   101-2. 


FOREIGN  EXCHANGE 

interest.  If,  however,  he  insists  on  making  the  6%  a 
discount  rate,  the  price  he  will  pay  for  the  instrument 
will  be  somewhat  reduced.  Should  the  exporter  desire  to 
avoid  the  loss  that  will  be  occasioned  by  this  change,  a  loss 
of  something  over  $6  in  the  case  in  hand,  he  will  have 
to  increase  the  amount  for  which  he  draws  by  approximately 
the  sterling  equivalent  of  this  sum.  In  a  ease  of  discount, 
the  exact  computation  should  take  the  following  form.  (It 
will  be  assumed  that  the  banker  will  take  his  commission 
"in  advance,"  just  as  by  taking  discount  he  takes  "interest 
in  advance.") 

Dollars  due  exporter $7,200.00 

Commission  of  banker,  M%  on  the  above 18.00 

Necessary  present  price  of  bill  inclusive  of  commission  7,218.00 
Dollar  returns  deferred  150  days  which  will  discount 

for  this  sum 7,403.08 

Found  as  follows: 

150  days'  discount  at  6%  per  annum  =  discount  of  2%% 
21/&%    of   the   assumed   future   return   in    dollars   being 
taken    out    of    same    as    discount,    the    present    dol- 
lars =97%%  of  the  future  sum 
Therefore  $7,218  =  97%%  of  future  dollars. 
If  $m%  =  $7,218,   100%  =  10%7.5  X  7>218  =  7,403.08 

$7,403.08  converted  to  sterling  at  rate  of  4.80 £1,542.31 

Face  value  of  the  draft,  £1,542.31  (£1,542.  6s.  2d.). 

The  accompanying  statement  to  the  importer  might  be  made 
up  as  shown  below. 

Amount  due  exporter  at  date  of  shipment $7,200.00 

Commission  to  banker,  at  M% 18.00 

Discount  charged  by  banker 185.08  12 


$7,403.08 
The  above  converted  to  pounds  at  rate,  $4.80=  . .  .£1,542  6s.  2d. 


12  Instead  of  $180.00  interest  as  shown  in  computation  on  p.  291. 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      299 

Sub-Sec.  11.  The  Reason  for  Sterling  Drafts  on  Out- 
lying Countries. — Since  drafts  from  the  United  States  on 
outlying  countries  for  dollars  are  simpler  and  involve  one 
less  risk  of  exchange  than  drafts  for  sterling,  the  question 
arises  as  to  wli3r  the  latter  alone  have  been  customary  until 
very  recent  times.  The  answer  is  found  in  the  first  in- 
stance in  the  fact  that  prior  to  the  great  war  there  was  in 
general  no  regular  or  established  market  for  New  York  ex- 
change in  the  trade  centers  of  these  outlying  countries. 
Therefore  the  importers  located  at  these  points  were  un- 
willing to  be  drawn  upon  in  a  manner  obligating  them  to 
purchase  and  return  New  York  or  dollar  drafts.  They 
were,  however,  able  and  willing  to  buy  sterling  bills  for  re- 
mittance to  this  country  or  to  London  for  its  account.  The 
established  markets  for  sterling  exchange  which  made  this 
feasible,  were  the  products  of  the  large  and  long  continued 
direct  trade  of  the  British  with  these  outlying  countries  and 
of  the  extensive  banking  business  conducted  by  British  con- 
trolled capital  in  them.  Thus  previous  to  1914,  bills  drawn 
in  the  United  States  on  South  American  countries,  South 
Africa,  India,  Australasia,  and  the  Orient,  were  usually 
drawn  in  sterling.13  Since  1914  the  American  practice  of 
drawing  upon  non-English  countries  for  sterling  has  been 
virtually  abandoned.  Not  long  after  the  outbreak  of  the 
war,  rates  for  sterling  exchange  fell  away  in  New  York  in  a 
manner  quite  without  precedent.  They  remained  uncertain 
until  the  middle  of  January,  1916.     From  that  time  until 

18  In  cases  where  the  importers  in  these  countries  provide  our 
exporters  with  sterling  letters  of  credit,  the  drafts  of  the  exporters 
are  drawn  direct  upon  London  banks.  These  are,  of  course,  sterling 
drafts,  but  are  not  the  type  of  drafts  of  which  we  are  now  speaking. 
Our  exporters  would  always  prefer  to  have  sterling  letters  of  credit 
provided  for  them  rather  than  to  draw  upon  the  importers  them- 
selves, even  in  sterling.  The  reason  why  the  use  of  the  letter  of 
credit  is  not  universal  is  primarily  because  of  its  expensiveness 
to  the  importers. 


300  FOREIGN  EXCHANGE 

.March  20,  1919,  they  possessed  an  extraordinary  stability, 
the  cable  rate  having  been  "pegged"  at  practically  4.76. 
During  the  period  of  the  instability  of  sterling  in  our  mar- 
kit,  the  draft  on  outlying  countries  for  sterling  returns 
became  from  our  point  of  view  anything  but  a  suitable 
method  of  settlement.  During  the  same  period  our  trade 
with  these  countries  gained  in  relative  importance,  some 
moderate  beginnings  in  the  establishment  of  American 
branch  banks  in  foreign  parts  took  place,14  something  of  a 
market  for  exchange  on  the  United  States  began  to  develop 
here  and  there,  and  in  the  case  of  exports  to  South  America 
and  the  Orient  drafts  for  dollars,  or  for  return  drafts  on 
this  country,  began  to  make  their  appearance.  Drawing 
for  dollars  upon  British  dominions  such  as  Australasia  and 
South  Africa,  has  not  however  become  the  practice.15 

Sub-Sec.  12.  Concerning  the  Use  of  a  Long-Term  Re- 
turn Draft. — Although  in  some  trades  return  sterling  bills 
at  sight  predominate,  and  in  our  trade  with  Latin  America 
such  bills  were  to  be  found,  in  the  latter  trade  return  ster- 
ling drafts  at  90  days'  sight  have  been  commonest  under 
normal  conditions.  The  question  occurs  as  to  what  difference 
it  makes  whether  such  drafts  are  at  this  long  usage  or  are 
at  sight.  It  makes  in  normal  times  no  great  difference  to 
the  exporter  or  to  the  bank  in  the  United  States  which  buys 
his  bill,  because  the  amount  drawn  for  in  either  case  is 
calculated  to  yield  a  predetermined  sum  of  dollars  in  New 
York,  a  certain  number  of  days  after  shipment  (as  150 
days16),  the  number  of  days  being  the  same  whether  the 

i*  One  American  institution,  the  International  Banking  Corpora- 
tion, had,  however,  established  branches  in  many  of  the  outlying 
countries  prior  to  this  time. 

is  This  is  explained  by  one  banker  as  being  due,  at  least  in  part,  to 
the  determined  opposition  of  the  local  British  banks  to  any  such 
development. 

i«  That  is,  150  days  in  case  of  shipments  to  Argentina,  and  other 
longer  or  shorter  periods  in  cases  of  shipments  to  other  countries. 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      301 

return  draft  is  at  sight  or  at  usance.  If  a  long  bill  is  re- 
mitted it  does  not  (under  conditions  when  it  can  be  and  is 
discounted  in  London)  yield  a  later  return  of  dollars  than 
a  sight  bill,  but  merely  a  reduced  return  in  dollars  per 
pound.  There  is,  however,  a  little  more  speculation (  in- 
volved in  drawing  for  the  remittance  of  a  long  bill  since  in 
this  case  the  actual  dollar  outcome  will  depend  in  part  upon 
the  position  of  the  London  discount  rate,  a  variable,  whereas 
the  dollar  value  of  a  return  bill  at  sight  will  have  no  direct 
dependence  upon  this  factor.17 

Considering  now  the  interest  of  the  importer  in  the  ques- 
tion whether  the  return  bill  is  to  run  for  a  term  or  to  be  at 
sight,  he  may  benefit  substantially  from  being  drawn  upon 
for  a  long-term  return  bill  instead  of  for  one  at  sight  pro- 
vided he  is  able  to  make  certain  arrangements  with  the 
banker  in  his  city  who  presents  the  exporter 's  original  draft 
to  him  for  acceptance  and  subsequently  for  payment.  In  our 
illustration  (page  286),  the  branch  of  the  South  American 
Banking  Corporation  at  Buenos  Aires  presents  the  export- 
er's draft  to  Lopez,  the  importer  and  drawee.  This  draft  it- 
self runs  at  90  days'  sight.  It  is  so  drawn  that  it  can  be  dis- 
charged at  its  maturity  by  the  purchase  and  return  of  a  90 
days '  sight  banker 's  bill  on  London.  This  bill  is  to  be  bought 
from  the  banker  that  holds  the  original  or  exporter's  own 
bill.  Thus  on  the  date  of  maturity  of  the  latter  instrument 
Lopez  is  required  to  obtain  from  the  South  American  Bank- 
ing Corporation  at  Buenos  Aires  its  90  days'  sight  bill  on  a 
London  bank.  The  question  is,  will  he  have  to  make  actual 
payment  (in  local  money,  or  pesos,  of  course)  for  this  bill 
at  this  time.  The  Banking  Corporation  will  not  have  to 
provide  cover  in  London  until  the  maturity  of  the  bill,  93 
days  after  its  arrival  in  that  city.     If  it  procures  this  cover 

17  There  is  an  indirect  relation  between  the  position  of  the  London 
discount  rate  and  the  rate  for  sight  drafts  on  London  in  New  York. 
Compare  §   144  below. 


302  FOREIGN  EXCHANGE 

in  Buenos  Aires  (the  normal  assumption)  it  may  wait  about 
90  or  93  days  (depending  upon  steamer  dates)  before  buy- 
ing it  in,  if  it  acquires  sight  drafts  on  London  as  the  cover, 
and  about  20  or  more  days  longer  if  it  buys  in  cable  trans- 
fers for  the  purpose.  Might  not  the  bank  then  permit 
Lopez  to  postpone  payment  to  it  until  the  time  arrives  for 
tlie  purchase  of  this  cover?  If  Lopez  has  sufficient  standing 
and  is  able  to  put  up  acceptable  collateral,  the  bank  may 
for  a  commission  extend  him  this  service.  Without  the 
service,  Lopez  will  be  required  to  pay  over  pesos  on  the 
date  of  maturity  of  the  draft  drawn  on  him:  with  it,  the 
evil  day  may  be  put  off.  Suppose  it  is  put  off,  and  cables 
are  bought  in  as  cover  on  the  latest  day  that  is  safe.  Lopez 
will  then  not  furnish  actual  local  money  (in  real  payment 
for  the  imported  goods)  until  perhaps  115  days  after  the 
maturity  of  the  draft  on  him !  The  postponement  will  cost 
him  something — in  addition  to  the  special  commission  he 
must  pay — because  the  cable  cover  will  cost  more  per  pound 
than  would  the  90  days'  sight  bill  if  bought  outright  in 
the  first  place.  This  is  in  the  nature  of  an  interest  cost. 
Will  the  postponement  at  this  cost  be  a  benefit  to  Lopez? 
Yes,  because  the  cost  will  be  substantially  at  a  rate 
of  interest  equal  to  the  London  discount  rate  on  banker's 
acceptances,  perhaps  4%  per  annum,  plus  commission, 
while  money  is  worth  perhaps  8  or  10%  per  annum 
locally.  So  when  the  importer  secures  an  extension  of 
time  in  this  manner,  which  is  possible  only  when  the  re- 
turn bill  runs  for  a  term,  he  enjoys  the  privilege  of  virtu- 
ally borrowing  monej^  at  London  rates  and  at  half  the  inter- 
est cost  of  local  rates.  This  is  a  complex  subject,  and  it 
may  well  be  that  extended  explanation  ought  to  be  offered, 
but  the  limitations  of  space  forbid  a  more  thorough  dis- 
cussion. There  is  no  grant  of  a  bank  credit  to  a  merchant 
or  letter  of  credit  involved  in  this  case,  but  the  service 
given  by  the  bank  at  Buenos  Aires  in  this  illustration  is 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER       303 

closely  analogous  to  that  given  by  the  bank  which  writes 
a  letter  of  credit  for  an  importer  and  permits  him  to  post- 
pone settlement  until  the  time  when  cover  for  the  long 
draft  drawn  under  the  letter  must  be  bought  in.18 

Sub-Sec.  13.  How  London  Indirectly  Finances  the 
Argentine  Import. — Some  London  bank  or  acceptance 
house  accepts  the  90  da3Ts'  bill  originating  in  Buenos  Aires, 
and  the  instrument  is  then  discounted  in  the  London  money 
market.  As  the  saying  goes,  the  London  money  market 
makes  an  advance  upon  it  of  93  days.  The  common  sup- 
position is  that  this  advance  aids  in  financing  the  shipment 
of  goods  in  connection  with  which  the  instrument  that  is 
discounted  originated,  and  this  supposition  is  correct.  It 
is  said  that  London  helps  finance  international  trade  the 
world  over.  The  case  in  hand  is  merely  one  example. 
Whenever  New  York  develops  a  similar  acceptance  and  dis- 
count business  it  will  be  engaged  in  extending  a  like  service 
to  the  commerce  of  the  world.  To  cut  short  a  story  that 
might  be  told  at  considerable  length,  the  effect  of  the  Lon- 
don discount  in  the  instance  of  our  present  illustration  is  to 
enable  Lopez  to  postpone  payment  in  pesos  for  the  goods 
which  he  has  imported,  about  a  quarter  of  a  year  longer 
than  if  he  had  been  compelled  to  buy  a  return  sight  bill  on 
England.  And  this  postponement  by  Lopez  does  not  make 
necessary  any  postponement  of  the  day  when  the  New  York 
bank,  which  purchased  the  exporter's  bill,  is  enabled  to 
recover  the  dollars  which  it  laid  out.  The  latter  institu- 
tion is  able  to  realize  upon  the  discounted  long  bill  as  early 
as  it  could  upon  one  drawn  at  sight,  while  Lopez  postpones 
payment  a  quarter  of  a  year  longer  because  of  being  per- 
mitted to  return  a  90  days'  bill. 

Lopez  is  then  in  the  case  before  us  the  ultimate  benefi- 
ciary of  the  London  money  market's  advance.     Some  money 

is  Compare  especially   §  44. 


304  FOREIGN  EXCHANGE 

dealer  in  London  voluntarily  pays  out  present  money  and 
waits  a  quarter  of  a  year  for  its  return — reaping  a  reward 
of  discount  or  interest — and  this  enables  Lopez  in  far-off 
Argentina  to  postpone  payment  for  his  imported  goods  a 
quarter  of  a  year  longer  than  otherwise.  To  finance  or  help 
finance  any  undertaking  means  to  aid  it  by  paying  out 
present  funds  and  awaiting  a  deferred  return.  So  London 
helps  finance  the  import  into  Argentina.  If  the  Argentine 
bank  should  refuse  to  give  an  extension  of  time  to  Lopez 
until  cover  for  the  same  bill  must  be  bought  in,  it,  instead 
of  Lopez,  would  be  the  beneficiary  of  the  advance.19  If  the 
New  York  bank  or  banking  agency  should  invest  in  the  long 
sterling  return  bill,  it  would  assume  the  burden  of  the  ad- 
vance instead  of  some  dealer  or  bank  in  London. 

Sub-Sec.  14.  Instructions  as  to  Drawing  on  South 
America. — The  following  memorandum  has  been  issued  by 
the  New  York  agency  of  a  certain  British  Bank.20 

Instructions  to  Drawers 

1.  In  drafts  drawn  for  pounds  sterling,  the  following  clause 

should  be  inserted :     "Payable  at  the  drawing  rate  of  the 

Bank  for  90  days'  bills  on  London  at  date  of  maturity." 

2.  Drafts  drawn  in  dollars  on  Argentina  should  contain  the 
clause :  "Payable  in  Argentine  gold  currency  at  bankers'  rate  for 
sight  drafts  on  New  York." 

3.  Drafts  drawn  in  dollars  on  Uruguay  should  read :  "Payable 
in  gold  currency  at  bankers'  rate  for  sight  drafts  on  New  York." 

4.  Drafts  drawn  in  dollars  on  Brazil  should  have  the  clause: 
"Payable  in  Brazilian  currency  at  bankers'  rate  for  sight  drafts 
on  New  York." 

5.  Shipping  documents  accompanying  time  drafts  will  in  every 

is  Considerations  of  space  forbid  making  so  complete  an  analysis 
of  this  problem  that  answers  will  be  given  to  all  the  questions  the 
inquiring  reader  might  ask. 

20  Reproduced  in  "Foreign  Credits,"  by  Archibald  J.  Wolfe,  De- 
partment of  Commerce  and  Labor,  Special  Agents  Series,  No.  62, 
1913,  pp.  399-400. 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      305 

case  be  delivered  to  drawees  against  acceptance.  If  payment  is 
required  upon  delivery  of  documents,  the  draft  must  be  made 
"at  sight." 

6.  All  drafts,  the  acceptance  or  payment  of  which  is  refused, 
will  be  protested,  unless  special  instructions  to  the  contrary  shall 
have  been  given.  The  bank  will  not  undertake  legal  proceedings 
without  being  so  instructed  and  secured  as  to  the  payment  of  all 
charges. 

7.  Drawers  in  the  United  States  having  agents  in  any  of  the 
countries  named  are  requested  to  notify  the  bank  in  writing  as  to 
what  authority  said  agents  hold  in  the  matter  of  extension  of  time 
of  payment  of  drafts,  delivery  of  documents,  etc.  No  instructions 
by  telephone  will  be  accepted. 

8.  Drawers  should  authorize  the  bank  to  receive  payment  for 
time  bills,  if  tendered  before  maturity,  stating  the  rate  of  discount 
to  be  allowed  for  their  account  to  drawees. 

9.  Drafts  with  documents  must  be  delivered  at  least  two  hours 
before  the  closing  of  the  mail  by  the  steamer  taking  the  goods 
drawn  for. 

Specimen  of  instructions  to  be  attached  to  drafts 

[To  be  detached  before  presentation;  strike  out  the  instructions 

not  required.] 
To   (Ltd.) ,  its  head  office,  branches, 

agencies,  and  correspondents. 

Instructions  to  be  observed  in  reference  to  draft  on 

£ 

Present  on  receipt. 

1.  Present  on  arrival  of  vessels  carrying  the  goods,  or 

days  after  receipt,  whichever  event  shall  first  happen. 

2.  Deliver  documents  to  drawee  on  [acceptance — pay- 
ment] of  draft. 

3.  In  case  of  need  refer  to ,  of 

4.  The  "in  case  of  need"  is  hereby  fully  empowered  to  instruct 
you  as  to  treatment  of  draft,  whether  by  variation  of  the  terms 
thereof  or  otherwise,  and  disposal  of  shipping  documents  or 
realization  of  goods,  or  the  variation  or  cancellation  of  any  pre- 
ceding clause,  and  you  arc  hereby  authorized  to  follow  his  direc- 


306  FOHKKiX  EXCHANGE 

tiona  as  to  dealing  with  the  goods,  documents,  and  draft  in  any 
manner  whatsoever. 

5.  Protest  for  nonaeceptanee. 

6.  Protest  for  nonpayment. 

7.  It  is  understood  that  the  negotiating  bank  or  its  agents  have 
the  power  to  decline  to  surrender  documents  unless  on  payment. 

8.  Rebate  at  the  rate  of   percent  per  annum  may  be 

allowed  if  paid  before  maturity. 

(Signature)   

§  72.  The  bill  with  an  interest  clause. — In  domestic  com- 
merce a  price  is  often  quoted  as  payable  a  specified  period 
after  the  shipment  or  delivery  of  goods,  without  the  addi- 
tion of  interest  for  the  delay  in  payment.  But  if  there  is 
coupled  with  such  a  quotation  an  offer  of  a  reduction  or 
concession  for  immediate  payment,  the  price  itself  in  reality 
contains  an  interest  charge.  Such  offers  are  very  common 
and  usually  take  the  form  of  a  "discount  for  cash"  at  a 
designated  rate  per  cent.  If  an  article  is  priced  at  $50 
"terms  60  days,  discount  for  cash  2%,"  a  buyer  that  takes 
the  60  days  time  pays  interest  at  the  rate  of  more  than 
12%  per  annum.  For  should  he  make  immediate  payment 
the  article  would  cost  him  $49  instead  of  $50,  and  in  effect 
he  pays  $1  of  interest  to  postpone  by  60  days  the  delivery  of 
$49.  This  is  interest  at  the  rate  of  2.04%  for  one-sixth  of 
a  year,  or  at  the  rate  of  approximately  12H%  per  annum. 
In  practice  discounts  for  cash  usually  represent  surprisingly 
high  rates  of  interest.  Except  in  the  retail  trade,  or  trade 
with  ultimate  consumers,  the  real  price  for  cash  is  gener- 
ally lower  than  the  price  quoted  for  payment  on  time,  and 
there  is  thus  present  in  the  latter  a  definite  charge  for  in- 
terest. 

In  foreign  trade — especially  in  the  export  trade  of  the 
United  States — the  quotation  of  a  price  payable  after  a 
time  coupled  with  an  offer  of  a  discount  for  cash  is  much 
less  common  than  in  internal  trade.     An  interest  charge 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      307 

for  delay  in  payment  is  not  however  forgotten.  It  is  merely 
not  so  frequently  registered  in  the  precise  form  of  a  "dis- 
count for  cash."  The  exporter  will  necessarily  have  his 
conditions  regarding  the  time  of  payment,  and  a  delay  in 
payment  by  the  importer  will  in  one  way  or  another  be 
made  to  cost  him  interest. 

In  some  cases  the  greater  the  delay  the  higher  will  be  the 
price  quoted  for  the  goods.  Thus  in  the  export  trade  from 
the  United  States  to  England  our  merchants  are  often  will- 
ing to  quote  prices  in  terms  of  sterling,  the  money  of  the 
importing  country,  and  to  draw  a  bill  having  a  face  value 
equal  to  the  price.  The  longer  the  term  of  this  bill  the 
greater  the  delay  in  payment  permitted  to  the  importer. 
If  the  instrument  is  to  be  drawn  at  90  days'  sight  the  price 
will  be  higher  than  if  it  is  to  be  drawn  at  60  days'  sight  or  at 
sight.  A  practically  identical  result  is  reached  in  the  same 
trade  if  the  price  is  quoted  in  dollars,  the  money  of  the  ex- 
porter's country.  Assuming  as  before  that  the  exporter 
draws  to  obtain  payment,  he  will  draw  a  bill  for  a  sufficient 
sum  of  sterling  to  sell  for  the  required  number  of  dollars. 
If  the  bill  is  at  90  days'  sight  he  will  have  to  draw  for  a 
larger  sum  of  pounds  than  if  it  is  at  60  days'  sight  or  at 
sight,  because  the  longer  the  term  of  the  bill  the  lower  the 
rate  it  will  fetch  in  our  exchange  market,  and  the  greater 
its  face  value  will  have  to  be.  Thus  the  longer  the  importer 
postpones  payment,  the  greater  the  amount  of  his  home 
currency  he  will  have  to  give  up,  and  thus  delay  costs  him 
virtual  interest  even  if  he  does  not  pay  straight  loan  or 
contract  interest. 

In  some  cases  an  express  interest  charge  will  be  added  to 
the  price  or  "invoice  cost"  of  the  goods  before  the  exporter's 
draft  is  drawn.  This  procedure  is  most  suitable  where  the 
draft  on  the  importer  is  drawn  for  some  kind  of  money 
other  than  the  money  of  the  importing  country,  as  in  the 
instances  of  the  drafts  on  Brazil  and  the  Argentine,  in  dol- 


308  FOREIGN  EXCHANGE 

lars  and  pounds  respectively,  reviewed  in  the  two  preceding 
sections. 

We  come  now  to  a  third  plan  of  dealing  with  the  interest 
charge.  This  is  the  method  of  introducing  an  interest 
clause  into  the  bill  on  the  importer.  Substantially  the  same 
result  is  produced  by  this  expedient  as  by  adding  interest 
to  the  invoice  cost  before  making  up  the  draft,  but  the  two 
methods  are  distinct  with  respect  to  the  externals  or  mere 
form.  The  reader  will  have  observed  that  the  drafts  on 
Brazil  and  Argentina,  considered  heretofore,  have  no  refer- 
ence within  themselves  to  interest.  As  a  matter  of  custom, 
the  interest  clause  is  commonest  in  drafts  upon  India  and 
the  Far  East.  It  appears  sometimes,  however,  in  bills  on 
Australasia  and  Latin  America. 

The  following  is  a  specimen  of  a  draft  containing  an  in- 
terest clause,  drawn  in  New  York  on  India  for  pounds 
sterling. 

£1,000.  New  York,  July  1,  1913. 

Sixty  days  after  sight  of  this  first  of  exchange  (second  unpaid) 
pay  to  the  order  of  the  Fiftieth  National  Bank  the  sum  of  One 
Thousand  Pounds  Sterling  payable  at  the  drawing  rate  of  the 
Chartered  Bank  of  India,  Australia  and  China  for  demand  drafts 
on  London,  with  exchange  and  collection  charges  including  inter- 
est at  6%  per  annum  added  thereto  from  date  hereof  to  approxi- 
mate due  date  of  arrival  of  the  remittance  in  London.  Value 
received.  James  P.  Smith. 

To  John  Doe, 
Calcutta. 

It  will  be  observed  this  is  a  draft  dischargeable  by  the  pur- 
chase and  remittance  of  another  draft  or  "return  draft"  as 
we  have  called  it.  That  is,  it  is  a  draft  payable  in  ex- 
change. This  is  the  only  form  of  draft  which  ever  bears  an 
interest  clause.  A  simple  bill  of  exchange,  namely  one 
drawn  for  a  specified  sum  of  the  money  local  to  the  place 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      309 

where  the  bill  is  payable  (the  ordinary  form),  is  never 
drawn  with  an  interest  clause,  at  least  where  commercial 
custom  is  known.  It  might  seem  reasonable  on  occasion  to 
draw  such  a  bill,  for  instance  in  this  form:  90  days  after 
date  pay  to  the  order  of  A.  B.  One  Thousand  Dollars  with 
interest  at  the  rate  of  6%  per  annum.  This  bill  would, 
however,  merely  call  for  $1,015  at  maturity,  and  according 
to  standard  practice  it  would  be  drawn  simply  for  the 
latter  sum  without  a  mention  of  interest. 

The  specimen  60  days'  draft  on  Calcutta  for  £1,000, 
given  above,  drawn  in  New  York  on  July  1st,  would  be 
likely  to  yield  returns  in  London  about  110  days  after  this 
date.  Assuming  then  that  the  parties  in  Calcutta  fix  upon 
the  "approximate  due  date  of  arrival  of  the  remittance  in 
London"  as  November  10th,  the  drawee  of  the  above  draft 
would  at  its  maturity  have  to  provide  a  sight  sterling  bill 
not  only  for  £1,000  but  for  this  plus  110  days'  interest  at 
6%,  making  a  total  of  £1,018  Is.  8d.  Also  he  will  have  to 
make  this  bill  cover  any  and  all  bankers'  commissions,  fig- 
ured in  sterling. 

If  then  a  New  York  banker  purchases  the  original  draft 
from  the  exporter  on  the  date  on  which  it  is  drawn,  he  buys 
a  claim  to  receive  £1,000  in  London  110  days  later,  with 
interest  on  this  sum  for  110  days  at  6%,  the  whole  being 
net  or  commission  free.  We  may  assume  that  the  banker 
will  ordinarily  take  the  bill  at  the  buying  rate  then  ruling 
in  New  York  for  merchants'  sight  bills  on  London.  He 
has  to  wait  much  longer  for  actual  returns  in  London  than 
when  he  buys  a  sight  bill  on  that  city,  but  he  receives  com- 
pensation for  this  at  the  relatively  high  rate  of  6%. 

If  now  the  exporter  can  sell  his  draft  at  the  prevailing 
rate  for  sight  sterling,  he  draws  for  the  number  of  pounds 
required  at  that  rate  to  yield  him  his  invoice,  or  the  dollar 
value  of  the  goods  shipped.  Thus  if  the  rate  is  4.84  (as- 
suming normal  rather  than  war-time  conditions),  and  if  the 


310  FOREIGN  EXCHANGE 

invoice  happens  to  be  just  $4,840,  he  draws  for  £1,000.  He 
adds  no  interest  to  the  invoice,  before  drawing,  because  the 
interest  clause  introduced  into  the  draft  itself  makes  it  an 
interest-bearing  instrument. 

§  73.  The  "colonial  clause." — The  colonial  clause  is  a 
stipulation  frequently  appearing  in  bills  on  South  Africa 
and  Australasia.  It  reads,  payable  with  exchange  (British 
and  colonial  stamps  added)  at  the  current  rate  in  London 
for  negotiating  bills  on  the  colonies.  It  can  properly  be 
introduced  only  into  bills  (1)  that  are  drawn  upon  British 
colonies  and  possessions  in  which  the  pound  sterling  circu- 
lates as  a  local  money  unit,  and  (2)  that  are  drawn  payable 
in  these  pounds  of  local  currency.  A  bill  drawn  for  pounds 
on  Rio  or  Buenos  Aires  is  payable,  so  far  as  pounds  go,  in 
pounds  of  London,  that  is,  by  a  return  draft  on  London. 
But  a  bill  bearing  the  colonial  clause,  drawn  let  us  say  in 
New  York  upon  Cape  Town  and  for  the  sum  of  £100,  is 
payable  in  the  pounds  sterling  in  circulation  in  the  Union 
of  South  Africa  (though,  for  reasons  yet  to  appear,  more 
than  100  such  pounds  would  be  required),  and  is  not  pay- 
able by  pounds  deliverable  in  London  or  by  a  return  draft 
on  London.  A  bill  with  the  colonial  clause  is  usually  drawn 
upon  a  merchant  and  not  upon  a  bank,  though  it  can  be 
drawn  upon  a  bank  for  the  account  of  a  merchant  when  a 
special  arrangement  for  this  is  made.  South  Africa  and 
Australasia  are  the  only  large  and  important  regions  upon 
which  bills  with  this  clause  are  drawn. 

The  phraseology  of  the  clause  leaves  its  meaning  far  from 
obvious.  The  parenthetical  expression,  "British  and  colo- 
nial stamps  added,"  is  designed  simply  to  shift  to  the 
drawee  any  stamp  taxes  that  may  be  levied  upon  the  bill  by 
the  British  or  colonial  governments.  These  words  omitted, 
the  stipulation  reads:  "payable  with  exchange  at  the  cur- 
rent rate  in  London  for  negotiating  bills  on  the  colonies." 
A  number  of  explanations  now  become  necessary.     At  the 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      311 

outset,  there  is  in  fact  no  single  rate  in  London  "for  nego- 
tiating bills  on  the  colonies,"  but  there  are  a  number  of 
rates  differing  according  to  the  length  of  life  of  the  bills 
and  according  to  the  colonies  upon  which  they  are  drawn. 
When,  however,  the  colonial  clause  is  introduced  into  any 
given  bill,  the  "current  rate  in  London"  means  the  par- 
ticular one  of  these  several  rates  that  is  quoted  in  London 
for  bills  of  the  same  term  and  domicile  as  the  given  bill.  To 
illustrate,  if  the  latter  (whether  created  in  New  York  or 
elsewhere)  is  drawn  at  60  days'  sight  on  South  Africa,  it 
will  be  payable  at  its  maturity  with  "exchange"  at  the 
rate  then  being  charged  in  London  upon  bills  at  60  days' 
sight  on  South  Africa. 

The  buying  rates  in  London  for  bills  on  the  colonies  are 
set  by  the  conjoint  action  of  the  several  great  colonial  banks 
that  have  branches  in  South  Africa  or  Australasia  and  in 
London  as  well.  In  contrast  with  ordinary  foreign  ex- 
change quotations,  these  rates  do  not  fluctuate  daily  and 
hourly  but  may  remain  quite  unchanged  for  very  consider- 
able periods,  in  this  feature  reminding  one  of  the  "posted 
rates"  of  New  York.  A  rate  between  pounds  sterling  of 
England  and  pounds  sterling  of  one  of  the  colonies,  bearing 
as  it  does  a  resemblance  to  a  rate  of  domestic  exchange,  may 
readily  be  quoted  (1)  as  a  rate  per  cent,  of  discount  or 
premium.  But  again  it  may  appear  (2)  as  a  price  in  local 
English  money  of  a  pound  or  of  100  pounds  of  colonial 
money.  In  the  London  Economist's  tables  both  forms  ap- 
pear, as  witness  the  following  examples,  taken  by  preference 
from  an  issue  of  that  journal  appearing  shortly  before  the 
beginning  of  the  great  war. 

London  on  South  Africa 

Buying  Rates 

Sight    V\r,%  discount. 

30  days'  sight 1      %  discount. 


312  FOREIGN  EXCHANGE 

Buying  Rates 

60  days'  sight 1%  %  discount. 

90  days'  sight 2%  %  discount. 

120  days'  sight 314  %  discount. 

London  on  Australia 
Buying  Selling 

Cable    100H 

98%  Demand    Par 

9814  30  days 

97%  60  days 

(From  the  Economist  for  June  27,  1914,  page  1575.) 

There  is  no  compelling  reason  why  exchange  on  South 
Africa  should  be  quoted  one  way  and  exchange  on  Australia 
the  other.  One  must  be  content  to  say  it  is  a  matter  of 
custom.  The  quotation  of  60  days'  sight  bills  on  South 
Africa  at  1%%  discount  means  simply  that  the  banks  are 
paying  for  such  bills  £98%  per  £100  of  face  value.  The  60 
da3's'  buying  rate  on  Australia  means  the  banks  are  giving 
£97%  for  an  ordinary  60  days'  sight  draft  on  Australia,  it 
pays  £97%  cash  down  in  London  to  receive  £100  of  Austra- 
lian money  63  days  (including  three  days  of  grace)  after 
the  arrival  and  acceptance  of  the  bill  in  that  commonwealth. 
In  other  words,  pounds  (1)  deliverable  in  Australia  and 
(2)  deferred  this  far  in  the  future  are  at  a  discount  of  214% 
when  bought  and  paid  for  with  pounds  (1)  in  London  (2) 
payable  cash  down. 

If  we  now  suppose  that  the  drawer  in  London  of  the  60 
days'  bill  on  Australia  for  £100,  adds  to  it  a  clause  which 
will  require  the  drawee  to  pay  not  only  the  face  value  but 
the  face  value  plus  a  premium  of  214%,  and  to  pay  also  all 
stamp  taxes,  we  shall  have  a  close  approximation  to  the 
colonial  clause  though  not  the  exact  thing  itself.  We  might 
imagine  the  drawer  explaining  to  the  drawee  the  meaning 
and  effect  of  this  (the  supposititious)  clause,  in  the  follow- 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      313 

ing  words :  "I  am  entitled  to  receive  £100  in  London  to-day 
against  goods  just  shipped  you.  Our  understanding  is  that 
my  bill  on  you  is  to  be  at  60  days'  sight.  If  now  I  draw  in 
the  ordinary  manner  for  £100,  I  will  have  to  sell  the  bill  at 
a  discount  of  £2T4  and  thus  receive  for  it  only  £97%,  saying 
nothing  of  the  stamp  taxes.  Therefore  I  am  adding  a 
clause  to  the  bill  requiring  you  to  pay  £21/4  extra,  and  the 
stamp  taxes  as  well.  I  find  that  if  I  do  this  the  banker  in 
London  will  give  me  £100  for  the  bill.  You  pay  enough 
extra  to  enable  me  to  get  £100  cash  down  and  clear."  If 
we  throw  this  clause  (still  the  supposititious  one)  into  the 
phraseology  most  closely  resembling  that  of  the  colonial 
clause  itself,  it  would  read:  "payable  with  exchange 
(British  and  colonial  stamps  added)  at  the  rate  current  on 
the  date  hereof  21  in  London  for  negotiating  bills  on  the 
colonies. ' '  This  would  mean  payable  with  stamp  taxes,  and 
with  "exchange"  of  £214,  added  to  the  face  value.  This  is 
"exchange"  at  the  rate  current  in  London,  namely,  the  rate 
of  2V±%  discount. 

This  introduces  us  to  a  meaning  of  the  word  exchange 
not  heretofore  encountered.  For  the  term,  as  just  used, 
signifies  the  discount  in  the  local  money  of  some  place  upon 
a  bill  payable  in  the  same  kind  of  money  at  a  distant  place. 
If  a  person  in  San  Francisco  having  a  right  to  $1,000  in 
New  York  sells  a  sight  draft  on  the  latter  city  for  this  sum 
and  is  able  to  get  only  $999.75  for  it,  he  may  call  the  dis- 
count of  25^  the  "exchange"  if  he  desires  to,  though  the 
word  will  be  used  in  a  sense  quite  distinct  from  its  other 
meanings.  In  a  similar  way  the  drawer  in  Loudon  of  the 
60  days'  bill  for  £100  on  Australia  may  speak  of  the  dis- 
count upon  it  of  £214  as  exchange,  and  may  communicate 
to  the  drawee  the  fact  that  he  is  to  pay  Z2M  extra  by  telling 
him  that  he  is  to  pay  the  bill  "with  exchange"  at  the  rate 

21  But  the  colonial  clause  moans  pai/ablc  at  the  rate  of  exchange 
current  on  the  date  of  payment.     Sec  text  to  follow. 


314  FOREIGN  EXCHANGE 

eurrenl  in  London  at  tlic  date  of  the  bill  for  negotiating 
drafts  on  Australia. 

Returning  now  to  the  bill  originating  in  New  York, 
drawn  at  60  days'  sight  on  Cape  Town  for  £100,  we  are 
prepared  to  understand  the  significance  of  the  colonial 
clause  which  will  be  added  to  it.  There  is  one  point,  how- 
ever, in  which  the  colonial  clause  differs  from  the  supposi- 
titious clause  which  we  have  been  considering.  "When  the 
colonial  clause  states  that  the  bill  is  payable  with  exchange 
at  the  rate  "current"  in  London,  etc.,  it  means  at  the  rate 
current  in  London  on  the  date  of  payment  of  the  bill  in 
South  Africa  and  not  on  the  date  of  the  drawing  of  the 
bill  in  New  York  or  any  other  date.  So  the  drawee  of  this 
bill  will  when  he  comes  to  discharge  it,  pay  the  £100  face 
value,  and  then  the  ' '  exchange ' '  equal  to  the  discount  ruling 
at  this  time  in  London  upon  ordinary  60  days'  bills  for  £100 
on  South  Africa  (this  being  in  our  illustration,  £1  12s.  6d.), 
and  finally  the  stamp  taxes.  The  precise  twist  given  to  the 
word  ' '  current ' '  in  the  colonial  clause  can  only  be  explained 
by  saying  it  is  the  custom. 

Assuming  that  on  the  date  when  the  bill  now  before  us 
falls  due  the  table  of  rates  which  we  have  already  copied 
from  the  London  Economist  holds  good,  the  total  amount 
payable  upon  it  will  be  computed  as  follows : 

Amount  drawn  for,  or  "face  value" £100 

"Exchange   at   the   rate   current    in   London," 

etc.,  at  1%%   1  12s.  6d. 

Stamp  taxes 

Colonial  Is.,  English  6d Is.  6d. 


£101  14s. 


The  English  stamp  tax  of  6d.  is  added  on  the  supposition 
that  the  bill  goes  through  London  and  is  negotiated  or  sold 
there  on  its  way  to  South  Africa. 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      315 

It  remains  now  to  make  quite  clear  the  reason  for  intro- 
ducing the  colonial  clause  into  the  bills  which  bear  it.  The 
advantage  is  that  it  has  the  effect  of  making  a  bill  worth  its 
face  value  in  pounds  in  London  if  offered  for  sale  in  that 
city  while  on  its  way  to  the  colonies.  Thus  the  bill  above 
considered,  although  payable  60  days  after  sight  in  South 
Africa,  will  sell  for  a  full  £100  in  London  on  arrival. 
(This  assumes,  of  course,  that  the  instrument  has  a  credit 
rating  justifying  its  purchase.)  A  further  effect  is  that  the 
bill  with  the  colonial  clause  sells  in  New  York  as  if  it  were  a 
sight  draft  on  London.  If  it  sells  for  its  face  value  in 
London  on  arrival,  it  is  obviously  the  equivalent  of  a  sight 
draft  of  the  same  face  value  on  that  city,  and  will  fetch  the 
same  rate  in  New  York  as  this  sight  draft.  The  convenience 
of  the  colonial  clause  to  the  New  York  exporter  thus  be- 
comes apparent.  As  the  saying  goes,  he  has  but  to  convert 
his  invoice  into  sterling  at  the  rate  in  New  York  for  sight 
bills  on  London  and  draw  for  the  amount  thus  calculated, 
and  this  rule  works  no  matter  what  the  usance  or  length  of 
term  for  which  he  is  to  draw  (provided  always  he  does  not 
draw  for  a  term  beyond  all  customary  limits  and  thus  make 
the  bill  unsaleable). 

To  illustrate:  A  of  New  York  makes  a  shipment  to  B 
of  Cape  Town  with  the  understanding  that  he  is  to  draw  at 
60  days'  sight  with  the  colonial  clause  added  to  the  bill. 
There  is  due  A  on  the  day  of  shipment  $12,000,  the  amount 
of  his  invoice.  Sight  sterling  (i.e.,  London  sterling)  is  say 
at  4.85.  A  converts  the  $12,000  to  sterling  at  this  rate, 
thus :—  12,000  -r-  4.85  =  £2,474.23  or  £2,474  4s.  7d.  Draw- 
ing the  bill  with  the  colonial  clause  for  the  latter  sum  as  its 
face  value,  he  may  sell  it  at  $4.85  per  pound  and  get 
$12,000. 

Even  if  the  bill,  being  bought  perhaps  by  the  New  York 
agency  of  a  British-Colonial  bank,  for  reasons  of  con- 
venience to  this  agency  should  not  actually  be  sent  through 


316  FOREIGN  EXCHANGE 

London,  it  is  still  worth  $4.85  per  pound  in  New  York. 
The  question  whether  the  bill  is  to  go  physically  through 
London  is  a  matter  of  indifference  to  the  exporter. 

From  this  point  forward  attention  will  be  directed  to 
certain  more  technical  aspects  of  the  colonial  clause. 

A  bank  in  London  will  pay  the  full  face  value  for  a  bill 
bearing  this  clause  despite  the  fact  that  the  instrument 
matures  after  a  considerable  period  and  is  dischargeable  in 
the  pounds  current  in  a  distant  land.  The  explanation  is, 
as  we  have  learned,  that  this  clause  compels  the  drawee  to 
pay  over  and  above  the  stated  face  value  a  certain  premium, 
and  as  well  the  stamp  taxes.  This  premium  serves  to  coun- 
terbalance the  discount  that  would  be  upon  the  bill  in  Lon- 
don if  it  bore  no  colonial  clause.  But  the  discerning  reader 
has  probably  observed  already  that  the  premium  is  not  the 
precise  theoretical  equivalent  of  the  discount  foregone  by 
the  banker.  Thus,  if  an  ordinary  60  days'  sight  bill  on 
South  Africa  for  £100  sells  in  London  at  a  discount  of  £2, 
the  addition  of  the  colonial  clause  to  it  will  require  the 
drawee  to  pay  a  premium  at  maturity  of  £2,22  and  for  this 
consideration  the  London  banker  pays  the  full  £100  for  the 
instrument.  Therefore  he  states,  as  it  were,  that  because 
he  is  willing  to  buy  100  deferred  colonial  pounds  for  £98 
of  London  cash,  he  is  also  willing  to  buy  102  pounds  of  the 
same  character  for  £100  of  London  cash.  In  the  first  case 
he  pays  98%  in  London  pounds  for  the  colonial  pounds, 
while  in  the  second  he  pays  98.04%.  This  little  matter  is 
however  ignored  in  practice.23 

Referring  to  another  curiosity  of  the  colonial  clause,  the 

22  Assuming  that  the  discount  in  London  is  still  £2  at  the  time 
of  the  maturity  of  the  bill  in  South  Africa. 

23  Stated  in  ultimate  terms,  in  the  first  case  the  banker  purchases 
on  the  basis  of  a  2%  discount  rate,  while  in  the  second  he  purchases 
on  the  basis  of  a  2%  interest  rate  which  makes  his  gain  slightly 
less.     Compare  §  14. 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      31? 

fact  that  the  premium  payable  on  the  bill  is  determined  by 
the  rate  of  discount,  on  a  similar  instrument,  current  in 
London  at  the  date  of  maturity,  instead  of  the  date  of  crea- 
tion or  first  negotiation,  means  that  at  the  time  of  purchase 
of  the  instrument  the  London  or  other  British  bank  takes  a 
speculation  as  to  what  the  premium  will  be  some  two  or 
three  months  later.  But  though  this  speculation  undeni- 
ably exists  in  connection  with  any  isolated  or  single  bill, 
the  speculation  involved  in  the  whole  continuing  business 
in  these  bills  is  practically  ironed  out  or  cancelled  out,  be- 
cause while  in  some  periods  the  premiums  may  turn  out  less 
than  the  discount  foregone  (these  being  periods  of  decrease 
in  the  rates  of  discount  in  London  on  colonial  bills),  in 
other  periods  (equally  numerous  in  the  long  run  so  far  as 
we  know)  the  premiums  will  turn  out  greater. 

Bills  upon  South  Africa  or  Australasia  originating  in 
England  do  not  customarily  bear  the  colonial  clause.  But 
a  substitution  for  the  clause  is  in  constant  use  by  English 
drawers.  Instead  of  enfacing  the  latter  on  their  bills  they 
simply  add  the  "exchange"  to  their  invoices,  and  reach  the 
same  result.  Thus  if  £100  is  due  the  English  exporter,  he 
adds  the  £2  for  exchange  to  the  invoice  and  (disregarding 
stamps)  draws  an  ordinary  bill  for  £102. 

When  reselling  drafts  originating  in  this  country  and 
bearing  the  colonial  clause,  American  bankers  are  likely  to 
deal  with  colonial  banks  which  have  New  York  offices  as  well 
as  London  branches  or  main  offices.  In  practice  they  are 
therefore  able  to  obtain  for  a  draft  either  a  credit  in  London 
(on  the  arrival  of  the  instrument)  for  its  face  value  in 
pounds,  or  the  dollar  value  of  the  same  in  New  York  at  the 
prevailing  sight  rate  on  London.  They  may  take  whichever 
suits  their  convenience.  Sometimes  the  colonial  banks  offer 
our  bankers  a  slight  premium  for  drafts  bearing  the  colonial 
clause. 

The  American  bank  indorses  the  bill  to  the  colonial  bank 


318  FOREIGN  EXCHANGE 

without  introducing  the  latter 's  place  of  business  into  the 
indorsement,  to  the  end  that  the  instrument  may  become 
transferable  to  and  be  negotiated  by  any  one  of  its  branches. 
If  the  bill  can  be  got  to  the  drawee  more  quickly  by  mailing 
it  direct  rather  than  through  London,  the  first  of  exchange 
will  be  forwarded  directly  to  the  branch  of  the  colonial  bank 
nearest  the  drawee,  for  the  earliest  possible  presentment  for 
acceptance,  and  the  second  of  exchange  will  be  mailed  to  the 
London  or  New  York  office  of  the  colonial  bank,  according 
to  convenience,  with  advice  as  to  what  has  been  done  with 
the  first  of  exchange.  It  will  in  this  case  be  the  second  of 
exchange  which  is  physically  sold  to  the  colonial  bank.24 

§  74.  Settlement  without  draft  by  exporter.  Delegations. 
— Despite  the  extreme  importance  of  the  exporter's  draft  as 
an  instrument  of  commerce,  settlement  may  be  managed 
without  it,  and  we  shall  at  this  point  consider  a  few  in- 
stances of  its  omission. 

Suppose  first  a  case  where  the  exporter  demands  "cash 
against  documents"  in  his  city,  meaning  that  he  must  re- 
ceive full  payment  in  local  cash  at  the  time  of  making  the 
shipment.  He  may  be  a  manufacturer  or  dealer  who  has 
no  desire  to  develop  a  foreign  business,  or  who  does. not 
care  to  enter  into  operations  in  exchange,  or  perhaps  he  is 
merely  unwilling  to  place  any  degree  of  confidence  in  the 
particular  foreign  buyer  in  the  case.  He  ought  to  be  satis- 
fied  with   a   confirmed   bank-credit,   if   that   were   offered 

24  The  Colonial  clause,  considered  apart  from  its  minor  provision 
regarding  the  payment  of  stamp  taxes  by  the  drawee,  is  in  reality 
a  somewhat  disguised  variant  of  an  interest  clause.  For,  so  long  as 
England  and  the  colonies  are  both  on  the  gold  standard  and  there  is 
freedom  of  traffic  between  them,  the  discount  in  London  on  a  bill 
upon  the  colony  will  consist  primarily  (though  not  by  necessity 
wholly)  of  interest.  In  making  the  drawee  pay  a  premium  equal  to 
this  discount,  we  are  making  him  pay  what  is  substantially  interest 
until  arrival  of  funds  in  London.  Space  is  lacking  for  an  extended 
discussion  of  this  point. 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER       319 

(under  which  normally  he  would  draw  a  draft),  but  sup- 
pose he  insists  on  the  delivery  of  actual  cash  and  the  im- 
porter assents.  The  latter  conceivably  might  buy  the  neces- 
sary amount  of  exchange  on  the  exporter's  country  and  send 
it  to  him,  saying  "now  then  please  ship  the  goods  and 
forward  me  the  bill  of  lading  and  other  papers."  But  this 
simple  scheme  would  in  general  be  open  to  the  objection  that 
it  requires  the  importer  to  place  too  much  reliance  in  the 
good  faith  or  solvency  of  the  exporter.  By  modifying  the 
plan  and  enlisting  the  services  of  the  banker,  the  importer 
may  gain  a  greater  protection  for  himself  and  still  meet 
the  demands  of  the  exporter.  He  induces  a  banker  of  his 
own  city  to  establish  a  cash  fund  or  cash  credit  in  a  bank 
in  the  exporter's  city  under  instructions  that  the  same  is  to 
be  paid  over  to  the  exporter  upon  his  delivering  up  the 
documents  covering  the  goods  to  be  shipped.  This  meets 
the  exporter's  terms  of  "cash  against  documents"  but 
avoids  the  risks  of  an  unqualified  prepayment  without  se- 
curity. To  increase  his  protection  the  foreign  merchant 
may  cause  to  be  appointed  a  person  to  inspect  the  goods  at 
the  place  of  origin  or  export,  and  have  the  bank  directed  not 
to  exchange  the  cash  for  the  documents  without  a  satisfac- 
tory report  from  this  inspector  with  regard  to  quantity, 
quality,  and  packing. 

It  is  apparent  this  case  is  one  in  which  it  is  possible  for 
settlement  to  be  completed  without  the  exporter's  drawing  a 
draft.  It  is  true  there  is  a  sort  of  bank  credit  established 
in  his  favor  under  which  he  might  draw  a  documentary 
sight  draft,  but  when  the  bank  in  question  is  located  in  his 
own  city  he  is  likely  to  exchange  the  documents  directly 
over  the  counter  for  cash  or  a  check,  a  draft  by  himself  thus 
being  eliminated. 

Id  a  second  case  remittance  by  the  importer  may  displace 
a  draft  by  the  exporter,  not  because  the  latter  \s  terms  are 
onerous  but  rather  because  they  are  liberal.     Thus  sales  to 


320  FOREIGN  EXCHANGE 

a  regular  and  highly  trusted  foreign  customer  may  be  made 
"on  open  account."  Transactions  are  on  open  account 
when  the  seller  simply  charges  the  buyer's  account  with  the 
amount  due  for  each  shipment  and  awaits  periodical  remit- 
tances from  the  buyer.  The  business  of  the  grocer  with  his 
ordinary  customers  who  settle  monthly,  is  a  very  homely  but 
accurate  illustration,  though  no  doubt  we  can  hardly  speak 
of  the  grocer's  deliveries  as  shipments.  Sales  on  open  ac- 
count are  much  commoner  in  domestic  trade,  but  they  are 
known  to  foreign  trade. 

Since  prior  to  quite  recent  times  drafts  by  shippers  have 
been  comparatively  very  rare  in  the  internal  trade  of  the 
United  States  and  remittances  of  bank  drafts  or  their  per- 
sonal checks  by  buyers  have  been  the  rule,  the  question  sug- 
gests itself,  wdiy  does  not  the  remittance  system  of  settle- 
ment have  a  greater  vogue  in  international  commerce.  The 
reason  is  simply  that  exporters  and  importers  located  in 
different  countries  characteristically  take  less  chance  on  the 
good  faith  or  solvency  of  one  another.  So  the  documentary 
draft  is  the  fashion  in  foreign  trade.  Of  course  the  risks 
are  differently  distributed  according  to  the  character  of 
the  draft,  according  for  instance  to  whether  it  is  drawn  on 
a  bank  under  a  credit  or  is  drawn  on  the  importer,  and 
according  in  the  latter  case  to  whether  the  documents  are 
for  acceptance  or  for  payment  only. 

There  remains  a  third  case  where  a  draft,  in  the  strict 
sense  of  a  bill  of  exchange,  is  not  drawn  by  the  exporter. 
The  exporter,  having  made  the  shipment,  takes  the  docu- 
ments to  his  local  bank  and  requests  it  to  forward  them  to 
a  correspondent  or  branch  in  the  importer's  city  with  in- 
structions that  they  be  surrendered  in  return  for  such  and 
such  a  sum  of  foreign  money,  or  for  such  and  such  an 
amount  of  exchange.  If  the  exporter  drew  a  documentary 
sight  draft  on  the  importer  and  had  it  forwarded  through 
these  same  banks,   practically   the   same   result  would  be 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      321 

reached,  but  this  draft  is  at  times  omitted  to  avoid  a  stamp 
tax  that  would  be  levied  upon  it.  Some  sort  of  written 
instrument  ought,  however,  to  accompany  the  documents  to 
make  definitive  what  payment  is  expected  in  return  for  them 
and  to  witness  the  authority  of  the  banker  to  collect  this. 
This  instrument  is  known  as  a  letter  of  delegation,  since  it 
delegates  to  the  banker  the  right  to  collect.  It  is  not  tax- 
able as  a  bill  of  exchange.  It  is  not  negotiable  in  the  legal 
sense  and  puts  the  parties  in  a  somewhat  different  legal 
position  from  the  one  they  would  occupy  if  a  bill  were  used, 
but  in  many  cases  this  makes  no  great  difference. 

§  75.  Advances  and  local  bank  acceptances  arranged  by  ex- 
porter.— The  right  of  the  exporter  to  draw  a  long  bill  on  a 
bank,  as  it  has  been  known  to  us  heretofore,  has  been  one 
arranged  for  by  the  importer.  But  where  the  importer  does 
not  agree  to  provide  such  a  right,  the  exporter  may  take 
steps  of  his  own,  at  his  own  bank  or  a  bank  in  his  vicinity, 
to  secure  a  similar  privilege.  When  the  importer  arranges 
the  bank  credit,  the  exporter  draws  a  bill  on  a  bank  instead 
of  a  bill  on  the  importer,  but  in  the  case  now  to  be  taken  up, 
he  draws  both  a  bill  on  a  bank  and  a  bill  on  the  importer. 
The  case  is  really  one  of  the  four  principal  arrangements 
under  which  a  bank  may  take  over  an  exporter's  draft  on 
the  importer,  and  is  best  explained  by  showing  its  position 
in  this  group.     The  four  arrangements  are : 

1.  Outright  purchase  of  the  draft 

2.  Receipt  of  the  same  for  collection  only 

3.  Receipt  for  collection  coupled  with  a  loan  or  advance  against 

the  draft  and  documents  as  collateral 

4.  Receipt  for  collection  coupled  with  a  grant  of  the  right  to 

draw  a  long  bill  against  the  expected  collections  as  cover 

(1)  An  outright  purchase  is  an  exchange  by  the  bank  of 
a  sum  of  present  casli  in  full  consideration  for  the  right  to 
collect  for  itself  all  money  forthcoming  from  the  draft.      |  1 1 


322  FORKKiX    KXCIIAXGE 

is  not  necessary  that  the  bank  surrender  its  right  of  re- 
course upon  the  drawer  to  constitute  the  transaction  a  pur- 
chase.) 

\2)  A  bank  taking  a  draft  for  collection  becomes  the 
agent  of  the  holder  or  depositor  of  the  instrument,  acquires 
authority  to  receive  the  sum  due  upon  it,  and  becomes 
charged  with  the  duty  to  account  to  the  depositor  for  this 
sum,  or  the  proceeds  of  it  after  appropriate  operations  in 
exchange.  Here  the  exporter  receives  nothing  until  the 
proceeds  of  the  collection  are  returned,  and  the  bank  has  no 
power  to  seize  and  sell  the  merchandise  collateral  in  its  own 
behalf  and  has  no  right  of  recourse  upon  the  exporter  as 
drawer. 

(3)  Against  the  receipt  of  a  draft  (or  a  letter  of  delega- 
tion) for  collection,  the  bank  may  make  the  exporter  a  loan 
of  a  certain  proportion  of  the  expected  returns,  charging 
interest  according  to  the  amount  and  period  of  this  ad- 
vance, and  holding  the  claim  against  the  importer,  and  also 
the  merchandise,  as  collateral  security.  The  plan  of  col- 
lection with  a  partial  advance  of  cash  is  very  common 
indeed. 

(4)  Finally  against  the  receipt  of  a  draft  (or  letter  of 
delegation)  for  collection,  the  bank  may  grant  the  exporter 
the  right  to  draw  a  long  bill  upon  itself  for  its  acceptance. 
The  idea  is  that  the  exporter  may  enter  the  open  market  to 
sell  the  accepted  bill  thus  created,  and  so  procure  the  pres- 
ent cash  for  which  he  nearly  always  hungers.25  The  opera- 
tion will  be  best  understood  by  conceiving  it  as  a  sort  of 
substitute  for  a  partial  loan  or  advance  of  cash  by  the  bank. 

The  term  of  the  new  bill — the  one  which  the  bank  ac- 

25  For  this  proceeding  the  name  of  "refinancing"  has  recently  been 
suggested.  If  the  accepting  bank  purchases  its  own  acceptance  the 
operation  becomes  virtually  identical  with  the  old-fashioned  advance 
against  the  exporter's  draft,  except  that  the  purchased  acceptance 
now  exists  as  a  bill  capable  of  rediscount. 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      323 

cepts — should  be  long  enough  to  make  certain  that  under 
ordinary  conditions  the  returns  from  the  draft  on  the  im- 
porter will  arrive  in  time  to  provide  for  its  discharge  at 
maturity.  These  returns  are,  in  other  words,  counted  upon 
to  serve  as  cover  for  the  acceptance.  This  is  the  "accept- 
ance arranged  for  by  the  exporter  himself"  referred  to  at 
the  beginning  of  the  present  section. 

For  an  illustration  suppose  an  exporter  brings  to  his  bank 
his  draft  on  a  certain  foreign  merchant,  a  draft  which  is 
expected  through  collection  to  yield  a  return  of  about  $10,- 
000  in  home  money  after  about  80  days.  Instead  of  making 
a  partial  advance  of  cash  against  this  instrument  as  col- 
lateral, the  bank  proposes  that  it  accept  a  90  days'  sight  bill 
to  be  drawn  on  it  by  the  exporter,  for  the  sum  let  us  say  of 
$7,500.  Since  this  bill  becomes  the  unconditional  obliga- 
tion of  a  bank,  it  will  sell  in  the  market  on  favorable  terms, 
and  assuming  it  is  discounted  at  a  rate  of  4%  it  will  fetch 
$7,425.  Suppose  the  collections  of  $10,000  from  the  im- 
porter arrive  just  in  time  to  provide  for  the  payment  of 
the  acceptance  at  maturity  by  the  bank.  They  will  be  ap- 
plicable first  to  this  very  purpose,  under  the  prior  claim 
created  in  favor  of  the  bank  at  the  time  it  grants  its  ac- 
ceptance. This  will  take  $7,500.  They  will  be  applicable 
second  to  the  payment  of  the  bank's  commission,  say  $37.50 
or  V2%.  The  remainder,  or  $2,462.50,  will  go  to  the  ex- 
porter. 

To  review  these  proceedings  from  the  standpoint  of  the 
exporter,  we  see  that  this  person  gave  up  the  chance  to  re- 
ceive $10,000  ninety  days  deferred,  and  received  instead 
$7,425  of  present  cash  and  $2,402.50  of  money  deferred 
ninety  days.  Thus  he  obtained  a  partial  advance,  not  it  is 
true  directly  from  the  bank,  but  through  its  aid.  This  ad- 
vance was  procured  at  a  cost  of  4%  per  annum  (discount 
rate)  plus  a  commission  of  ^%  per  quarter,  or  a  commission 
figuring  a]  2%  per  annum.     The  interest  cost  was  thus  evi- 


324  FOREIGN  EXCHANGE 

dently  about  6%  per  annum,  but  if  we  desire  to  compute  the 
exact  rate  we  must  proceed  as  follows: 

(In  this  computation  we  take  90  days  as  x/±  of  a  year.) 
Exporter's  repayment  to  bank,  or  sum  taken  from  col- 
lections by  bank 
Amount  to  discharge  bank's  acceptance. .  $7,500.00 
Bank's  commission 37.50 

$7,537.50      $7,537.50 
Present  cash  received  by  the  exporter  from  sale  of 

the  acceptance 7,425.00 

Difference    112.50 

This  difference  is  the  interest  cost  for  an  advance  of 

$7,425  for  a  period  of  Vi  year. 
Per  cent,  of  interest  for  Vi  year 1.515% 

(That  is,  112.50  is  1.515%  of  7,425) 
Rate  of  interest  per  annum  (4  X  1-515) 6.06  % 

In  this  operation  the  bank  does  not  make  interest.  It 
makes  no  advance  of  actual  money  or  money  funds.  The 
cash  for  the  exporter  comes  from  the  "market,"  or  more 
specifically,  from  the  one  with  whom  he  discounted  the  ac- 
ceptance. The  only  takings  of  the  bank  are  its  commission 
of  $37.50.  This  is  a  compensation  for  the  risk  it  has  as- 
sumed in  becoming  unconditionally  bound  upon  the  bill  it 
accepted.  If  the  returns  from  the  importer  were  to  fail 
entirely,  if  the  merchandise  were  lost,  and  if  the  exporter 
became  worthless  in  a  business  sense,  the  bank  would  have  to 
pay  the  $7,500  due  on  its  acceptance  just  the  same.  The  fact 
that  the  rate  of  commission  tends  to  be  higher  the  longer 
the  period  during  which  the  bank  carries  this  risk,  makes 
it  look  somewhat  like  a  rate  of  interest,  but  it  is  emphati- 
cally not  this.26  The  bank  should,  of  course,  exercise  the 
same  care  in  granting  an  acceptance  against  an  exporter's 

26  Compare  §  50. 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      325 

claim  on  an  importer  as  it  would  in  making  a  partial  ad- 
vance of  cash  against  the  same  security. 

For  a  bank  by  this  means  to  aid  an  exporter  to  procure 
cash  in  the  open  money  market  is  not  to  be  regarded  as 
discreditable  but  rather  as  a  legitimate  and  useful  business. 
The  type  of  acceptance  before  us  at  the  present  moment, 
like  any  other,  should  be  granted  only  with  a  due  regard 
for  the  limits  set  by  law  or  propriety  upon  the  total  of 
acceptances  which  a  bank  ought  to  have  outstanding  at  any 
one  time  or  ought  to  have  outstanding  in  behalf  of  any  one 
business  house.  Under  present  Federal  statutes  the  grant- 
ing of  acceptances  against  deposited  exporter's  drafts  is 
strictly  lawful,  and  there  is  nothing  in  the  origin  of  such 
acceptances  making  them  ineligible  for  rediscount  with  a 
Federal  Reserve  bank. 

The  fact  that  in  any  given  instance  an  American  exporter 
draws  on  a  home  bank  does  not  in  itself  show  whether  he 
or  the  importer  has  arranged  for  the  right  to  draw.  For 
the  importer,  although  acting  practically  always  through  a 
bank  in  his  own  country,  might  have  provided  a  commercial 
credit  with  one  of  our  banks,  that  is,  a  so-called  "dollar 
credit. ' '  This  case  would  be  but  a  variant  form  of  the  one 
already  discussed  in  the  chapter  on  the  commercial  credit. 
It  is  safe  to  say  that  until  quite  recently  the  drawing  by 
American  exporters  of  long  bills  on  American  banks  was 
virtually  unknown.  But  to-day  our  exports  are  to  an  extent 
being  financed  in  this  manner,  and  some  of  the  instances 
are  ones  where  the  exporter  himself  arranges  for  the  draft 
on  the  bank.  London  bankers  have  before  this  been  grant- 
ing English  exporters  acceptances  against  their  drafts  on 
importers  in  outlying  countries.'-7 

§  76.  Terms  and  methods  of  settlement  summarized. — In 
connection  with  the  export  of  goods  there  arise  many  tech- 

"  ,Vee  W.  F.  Spaulding'a  "Foreign  Exchange  and  Foreign  Bills," 
pp.  164-5,  especially  at  bottom  of  p.   165, 


326  FOREIGN  EXCHANGE 

oica]  problems,  such  as  packing,  routing,  insuring,  trans- 
shipping, the  preparation  of  consular  invoices  and  certifi- 
cates of  origin,  and  the  clearing  of  the  goods  through  the 
custom-houses  at  the  ports  both  of  export  and  of  import, 
to  say  nothing  of  the  problems  of  the  financing  of  shipments 
or  arranging  methods  of  settlement.  In  the  handling  of 
foreign  commerce  many  specialized  functionaries,  quite  dis- 
tinct from  the  ordinary  rail  and  water  transportation  com- 
panies, manage  to  find  employment.  Such  are  resident  sales 
agents,  manufacturers'  export  agents,  export  commission 
houses,  foreign  freight  forwarders,  and  custom-house 
brokers.  With  the  exception  of  problems  of  settling  for 
and  financing  shipments,  the  special  commercial  art  of 
export  lies  beyond  the  purview  of  the  present  book,  but  we 
should  realize  that  methods  of  settlement  are  likely  to  be 
much  influenced  by  the  intervention  of  sales  or  export  agents 
or  export  commission  houses,  especially  the  latter.  For  in- 
stance the  merchant  in  a  foreign  land  who  wishes  to  buy  an 
■article  manufactured,  let  us  say,  in  Detroit,  may  be  able  to 
arrange  more  satisfactory  terms  by  dealing  with  or  through 
a  New  York  export  commission  house  than  by  dealing 
directly  with  the  manufacturer. 

The  principal  subjects  of  a  contract  of  sale  are : 
(1)  the  quantity  and  quality  of  the  article  to  be  sold  (in 
brief,  the  goods),  and  (2)  the  amount  and  kind  of  money  to 
be  paid  for  these  articles  (in  brief,  the  price).  But  there 
are  a  number  of  secondary  or  collateral  matters  which  the 
contract  must  determine,  whether  expressly  or  impliedly, 
such  as: 

1.  The  time  when  the  buyer  must  make  payment, 

2.  The  manner  or  mode  in  which  he  shall  pay  (whether 

by  remittance  or  by  submission  to  draft), 

3.  The  allocation  of  the  incidental  costs  such  as  cartage, 

freight,  insurance,  customs  duties,  and  the  like,  and 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      32V 

4.  The  allocation  of  the  interest  charge  for  the  period  of 
the  transit  of  the  goods. 

By  the  allocation  of  these  costs  or  charges  we  mean  their 
distribution  between  seller  and  buyer.  Charges  resting 
upon  the  seller  may  be  spoken  of  as  "included  in  the  price." 
The  elements  of  the  agreement  which  we  here  distinguish 
as  secondary,  are  in  common  speech  known  as  the  "terms" 
of  the  sale.  When  the  seller  makes  known  his  demands 
with  respect  to  these  matters,  he,  as  we  say,  states  his 
terms. 

In  the  list  to  follow,  we  give  the  chief  terms  pertaining 
to  time  of  payment,  that  are  familiar  to  foreign  commerce. 
In  this  list  the  order  is  from  the  strictest  to  the  most  liberal 
of  conditions. 

TERMS  Appropriate  Method  of 

Settlement 

I.  CASH  WITH  ORDER Remittance  by  importer  to  ex- 

porter, in  regular  practice  ol' 
a  sight  draft  oh   a  bank  in 

the  exporter's  country. 

II.  CASH    AGAINST    DOCU- 

MENTS AT  PLACE  AND 

TIME  OF  SHIPMENT. ...  1  Remittance  as  above,  but  re- 
mitted draft  held  by  agent 
of  the  importer  until  ex- 
porter exchanges  shipping 
documents  for  draft,  im- 
porter gaining  control  of 
documents  when  making 
payment. 

2  Payment       for      documents 

through  a  bank  (see  text). 

3  Payment  for  documents  by  ;i 

commission     house     which 
advances  Eor  the  importer 


328  FOKEIGN   EXCHANGE 

flic  amount  thus  paid, 
usually  against  the  docu- 
ments and  goods  as  col- 
lateral. 
4  Provision  by  the  importer  of 
a  good  commercial  credit 
with  a  bank  (ought  to  be 
satisfactory  under  terms 
"cash  against  documents"). 

III.  PAYMENT  FOR  DOCU- 
MENTS AT  POINT  OF 
DESTINATION 

(A)  On    Arrival    of    Docu- 

ments    Sight  draft  or  letter  of  delega- 
tion of  exporter  on  importer, 
with  documents  attached. 

(B)  On    Arrival    of    Goods 

(to  allow  opportunity 

to  inspect  goods) Same    as    above,    except    that 

draft  accompanied  by  in- 
structions that  presentment 
for  payment  be  deferred  un- 
til arrival  of  goods. 

(C)  Within     a    Designated 

Period  After  Arrival 

of   Documents    Long  draft  by  exporter  upon 

importer,  documents  attached 
and  documents  for  payment, 
the  privilege  of  prepaying 
being  understood. 

(D)  Within    a    Designated 

Period  After  Arrival 

of  Goods  Same  as  above,  except  instruc- 
tions given  to  withhold  pre- 
sentment for  acceptance  until 
arrival  of  goods. 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      320 

IV.  ACCEPTANCE28  IN  RE- 
TURN FOR  DOCUMENTS 
DELIVERED  AT  POINT 
OF  DESTINATION 

(A)  On    Arrival    of    Docu- 

ments        Long  draft  by  exporter  upon 

importer,  documents  at- 
tached, documents  for  accept- 
ance. 

(B)  On  Arrival  op  Goods.  . .    Same  as  above,  except  instruc- 

tions given  to  withhold  pre- 
sentment for  acceptance  un- 
til arrival  of  goods. 

V.  SALE  ON  ACCOUNT  CUR- 

RENT, "OPEN  ACCOUNT" 

OR  "OPEN  CREDIT" Periodical  remittance  by  im- 
porter to  exporter,  usually  of 
a  sight  draft  on  a  bank  in  the 
exporter's  country. 

"Cash  with  order,"  the  least  liberal  of  terms  recognized 
in  ordinary  commercial  practice,  signifies  that  the  buyer 
must  make  payment  when  placing  the  order  with  the  seller. 
Practically,  these  terms  come  to  this,  the  buyer  must  make 
payment  before  the  seller  will  act  upon  or  incur  any  ex- 
penses in  connection  with  the  order.  If  an  exporter  who 
quotes  these  terms  has  the  goods  in  stock  he  declares  in 
effect  he  will  not  do  so  much  as  to  pack  and  deliver  them  to 
the  transportation  company  without  receiving  cash  in  ad- 
vance. If  he  does  not  have  the  goods  in  stock  he  will  not 
purchase  or  assemble  them  without  prepayment,  or  if  a 
manufacturer,  he  will  not  start  them  in  process  or  assume 
any  costs  of  production  without  prepayment.     The  terms 

28  Acceptance  having  the  effect  of  binding  the  drawee  uncondi- 
tionally to  any  holder  in  due  course,  which  a  buyer  of  the  instrument 
will  usually  be. 


330  FOREKiX   EXCHANGE 

"cash  wiili  order"  are  very  burdensome  to  the  foreign 
buyer,  first  because  they  require  him  to  find  cash  or  lock  up 
funds  a  considerable  time  before  he  can  realize  upon  the 
goods  (whereas  what  he  likes  best  is  to  pay  for  the  goods 
out  of  the  amount  he  realizes  from  their  sale),  and  second 
because  they  require  him  to  repose  a  maximum  of  unre- 
quited confidence  in  the  exporter,  for  he  must  trust  to  the 
latter  to  pack  properly  and  ship  within  a  reasonable  time 
the  right  kind  and  quantity  of  article.29  Considering  that, 
except  in  cases  where  he  has  a  long-standing  acquaintance- 
ship with  the  exporter,  an  importer  usually  has  a  strong 
desire  to  inspect  the  goods  at  destination  before  even  com- 
mitting himself  to  the  extent  of  an  acceptance,30  one  might 
wonder  if  he  "would  ever  submit  to  the  terms  "cash  with 
order."  Nevertheless  some  foreign  buying  in  a  small  way 
takes  place  under  these  terms. 

The  phrase  "cash  against  documents"  signifies  that  the 
importer,  whether  acting  for  himself  or  through  an  agent, 
will  be  required  to  make  payment  before  the  shipping  docu- 
ments, and  thus  the  control  of  the  goods  is  surrendered  to 
him.31  But  the  practical  force  of  the  phrase  remains  uncer- 
tain unless  it  is  supplemented  with  an  understanding  as  to 
the  place  where  the  importer  is  to  make  this  payment  and 
take  up  the  documents.  This  might  be  the  point  of  origin, 
the  port  of  export,  the  port  of  import,  or  the  place  of 
destination  when  this  is  distinct  from  the  port  of  import, 
but  in  the  great  majority  of  cases  where  terms  are  quoted 
in  the  exact  phraseology  "cash   against   documents"  the 

29  Failure  of  the  exporter  to  live  up  to  the  agreement  of  sale  would 
of  course  create  in  the  importer  a  right  of  action  at  law,  but  it  is  so 
difficult  and  so  expensive  to  enforce  a  right  or  to  get  damages 
in  the  courts  of  a  distant  country  that  the  aggrieved  party  in 
international  commerce  regards  resort  to  the  law  with  little  enthu- 
siasm. 

so  That  is,  to  the  extent  of  accepting  a  bill  upon  himself. 

8i  On  his  agent  or  banker. 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      331 

place  of  taking  up  the  documents  will  be  within  the  ex- 
porter's country.  Thus,  speaking  of  a  quotation  from  the 
United  States,  we  might  have  "cash  against  documents  in 
New  York"  or  "cash  against  documents  in  Detroit,"  or 
some  other  interior  point  of  origin.  If  the  intention  were 
to  have  the  importer  exchange  money  for  the  documents  at 
the  place  of  destination,  as  say  Rio,  the  words  "cash  against 
documents  at  Rio"  might  be  employed,  but  the  intention 
would  be  better  expressed  and  more  usually  expressed  in 
the  phrase  "sight  draft  with  documents."  A  sight  draft, 
with  the  documents  attached  and  deliverable  against  pay- 
ment of  the  draft,  would  of  course  be  the  most  appropriate 
means  of  putting  this  intention  into  effect,  unless  perchance 
the  exporter  should  have  an  agent  at  Rio  who  could  per- 
sonally deliver  the  documents  for  local  cash  or  for  sight  ex- 
change on  New  York  or  London. 

Under  the  terms  ' '  cash  against  documents, ' '  the  exporter 
buys  or  manufactures  the  goods,  packs  them  and  makes  de- 
livery to  the  transportation  company,  before  'receiving 
payment.  Thus,  except  in  cases  of  fraud  or  mistake,  the 
importer  makes  no  disbursement  until  the  wares  are  in 
existence  and  under  way  to  him  and  the  shipping  docu- 
ments are  under  his  control.  The  exporter  makes  all  his 
expenditures  connected  with  the  transaction,  before  he  re- 
ceives payment,  but  he  does  not  give  up  the  shipping  docu- 
ments or  documents  of  title  before  payment.  While  the 
terms  "cash  against  documents"  are  by  no  means  so  strict 
as  "cash  with  order,"  they  are  regarded  by  the  ordinary 
importer  as  very  illiberal. 

The  more  appropriate  methods  of  settlement  to  be  fol- 
lowed under  the  terms,  "cash  against  documents"  at  the 
place  of  shipment,  have  been  indicated  in  the  conspectus 
already  given.  The  importer  may  remit  a  draft  payable 
in  the  exporter's  country  for  the  requisite  sum  of  the  money 
of  that  country,  to  an  agent  who  will  thus  be  put  in  funds 


332  FOREIGN  EXCHANGE 

to  take  up  the  documents  for  him.  Any  method  whereby 
this  agent  may  be  placed  in  funds  will  of  course  serve. 
The  importer  may  induce  his  home  bank  to  make  arrange- 
ments with  some  bank  in  the  neighborhood  of  the  exporter 
to  take  up  the  documents.  The  institution  thus  paying 
for  the  documents  will  reimburse  itself  in  some  appropriate 
and  convenient  manner  at  the  expense  of  the  importer's 
bank,  and  the  latter  will  sooner  or  later  collect  payment 
from  the  importer  himself.  The  bankers  will,  of  course, 
charge  commissions.  The  importer  may  induce  a  commis- 
sion house  located  near  the  exporter  to  take  up  the  docu- 
ments for  him,  there  being  several  possible  arrangements 
between  himself  and  the  commission  house.  To  give  one 
illustration,  this  house  may  draw  on  the  importer  a  bill, 
perhaps  a  long  one,  with  documents  attached.  In  this  case 
some  might  be  inclined  to  regard  the  commission  house  as 
the  true  exporter,  but  this  will  depend  upon  how  we  define 
the  term  "exporter,"  a  question  which  we  shall  avoid  open- 
ing here.  If  the.  importer  provides  a  commercial  credit 
with  a  good  bank,  especially  if  it  is  a  confirmed  credit,  this 
ought  to  satisfy  a  reasonable  exporter  who  has  stated  his 
terms  as  "cash  against  documents."  For,  as  we  already 
know,  under  ordinar}-  conditions  this  will  enable  him  to 
obtain  cash  in  full  at  the  time  of  surrendering  the  docu- 
ments at  the  point  of  shipment.  One  may  object  however 
that  this  is  not  quite  equivalent  to  the  receipt  of  an  outright 
and  final  payment  of  cash,  for  the  reason  that  the  exporter 
incurs  drawer 's  liabiliy  on  the  draft  which  he  creates  under 
the  credit.  The  objection  is  genuine  but  not  very  substan- 
tial because  recourse  upon  the  drawer  could  come  in  this 
case  only  in  the  event  of  the  failure  of  the  drawee-bank  to 
honor  an  authorized  draft  upon  itself,  a  danger  in  general 
to  be  regarded  as  negligible.  In  this  case  the  exporter  has 
no  stake  in  the  solvency  or  reliability  of  the  importer  (com- 
pare §  49). 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      333 

On  the  other  hand,  draft  by  the  exporter  upon  the  im- 
porter in  person  would  not  meet  the  terms,  "cash  against 
documents"  at  the  point  of  shipment  even  if  this  draft 
should  be  readily  salable  for  cash.  For  here  recourse  upon 
the  exporter  would  be  brought  about  if  for  any  reason  the 
importer  failed  to  honor  the  bill,  and  thus  the  exporter 
cannot  regard  the  cash  received  from  the  sale  of  this  in- 
strument as  his  own  then  and  there  as  a  matter  of  practical 
finality. 

The  agreement  of  sale  may  prescribe  payment  for  the 
documents  at  the  point  of  destination,  or  if  yet  more  liberal 
ma}-  require  merely  an  acceptance  in  return  for  the  docu- 
ments at  this  point.  The  several  methods  of  settlement 
suitable  to  these  conditions  are  set  forth  in  the  table  already 
presented,  and  should  be  in  the  main  self-explanatory. 
However,  an  additional  word  seems  advisable  with  regard 
to  postponement  of  presentment  until  the  importer  has  op- 
portunity to  inspect  the  goods.  It  is  very  common  of  course 
for  a  draft  and  attached  documents  to  reach  destination 
prior  to  the  arrival  of  the  merchandise  to  which  they  apper- 
tain. If  the  draft  is  owned  by  the  bank  at  the  place  of 
destination,  or  by  some  other  bank  for  which  it  acts  as  agent 
— if  in  other  words  the  draft  has  been  bought  from  the  ex- 
porter instead  of  having  been  taken  merely  for  collection — 
it  must  be  presented  to  the  drawee,  whether  for  payment  or 
for  acceptance  (where  presentment  for  acceptance  is  neces- 
sary), within  a  reasonable  time  if  the  right  of  recourse  upon 
the  exporter  as  drawer  is  to  be  preserved.  But  importers 
are  in  many  cases  extremely  averse  to  paying  or  accepting 
a  draft  before  the  goods  arrive  and  become  open  for  inspec- 
1  ion.  Especially  is  this  true  of  importers  resident  in  South 
America.  In  determining  whether  presentment  has  taken 
place  within  a  reasonable  time,  regard  must  be  had  (ac- 
cording to  both  English  and  American  law)  to  the  nature  of 
the  instrument,  the  usage  of  trade  or  business  (if  any)  with 


334  FOREIGN  EXCHANGE 

respecl  to  such  instruments,  and  the  facts  of  the  particular 
case.  How  far  a  bank  might  go  in  postponing  presentment 
with  a  view  to  permit  the  arrival  of  the  goods  and  inspec- 
tion, without  destroying  the  right  of  recourse,  is  a  question 
which  so  far  as  the  present  writer  can  learn  has  not  heen 
adjudicated  in  America  or  England.  But  it  is  clear  that 
the  drawer's  express  consent  to  such  a  postponement  ought 
to  be  a  matter  of  record  if  the  postponement  is  to  be  made, 
and  some  bankers  at  least,  dealing  in  bills  on  South  Amer- 
ica, make  a  practice  of  requiring  the  drawer  to  give  in- 
struction on  the  matter.32  A  postponement  on  the  drawer's 
order  or  with  his  consent  will  not  terminate  the  right  of 
recourse  on  him.  (The  foregoing  gives  such  explanations 
as  seem  necessary  in  connection  with  cases  III  B,  III  D, 
and  IY  B  as  set  forth  in  the  table.) 

It  has  been  stated  that  among  the  collateral  matters  to  be 
determined  bj^  the  agreement  of  sale  is  the  question  of  the 
allocation  of  the  incidental  costs  of  cartage,  freight,  in- 
surance, customs  dues  and  brokerage,  and  similar  charges. 
When  an  exporter  quotes  a  price  to  a  prospective  buyer  it 
is  important  there  should  be  a  definite  understanding  as  to 
just  how  many  of  these  incidentals  are  payable  by  the  ex- 
porter under  this  quotation.  If  the  agreement  of  sale  is 
silent  on  this  subject,  the  buyer  is  supposed  to  receive  the 
goods  at  the  place  where  they  are  when  the  bargain  is 
struck,  and  to  carry  all  expenses  and  risks  from  this  point 
forward.  The  terms  respecting  incidental  charges  most 
common  in  practice  are  the  ones  represented  by  the  abbre- 

32  Cf.  p.  305.  The  following  is  quoted  from  a  pamphlet  upon 
"Export  Trade  to  Central  and  South  America"  issued  in  1917  by 
the  Mechanics  and  Metals  National  Bank  of  New  York,  p.  16.  "Re- 
member that  practically  all  over  South  and  Central  America  mer- 
chants have  the  right  to  await  the  arrival  of  the  merchandise  before 
accepting  a  time  draft  or  paying  a  sight  draft.  Bear  in  mind  that 
in  those  countries  the  documents  attached  to  a  time  draft  must 
always  be  delivered  to  the  drawee  against  his  acceptance." 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      335 

viations  F.  0.  B.  and  C.  I.  F.     The  meaning  of  these  and 
certain  other  related  symbols  are  given  beneath. 

F.  0.  B.  or  "Free  On  Board." 

F.  A.  S.  or  "Free  Along  Side" 

C.  I.  F.  or  "Cost,  Insurance,  and  Freight" 

included. 
C.  F.  or  C.  A.  F.  or  "Cost  And  Freight"  included. 
Franco  Domicile.   (A  European  expression.     See  text.) 

If  a  quotation  is  F.  0.  B.,  the  seller  undertakes  for  the 
price  named  to  deliver  the  goods  on  board  car  or  ship  at 
a  designated  place,  free  of  charges  to  the  buyer.  The  terms 
become  definitive  only  when  this  place  is  stated  or  under- 
stood. Goods  may  be  sold  F.  0.  B.  at  the  point  of  origin 
(as  say  Detroit),  or  at  the  port  of  export  by  sea  (as  New- 
York),  or  again  at  some  point  further  on,  as  the  port  at 
the  end  of  the  sea  passage  (as  say  Genoa).  In  the  absence 
of  specification  of  the  place  where  the  goods  are  to  be 
F.  0.  B.,  the  point  of  origin  would  be  implied,  unless  an 
established  usage  of  the  trade  gives  rise  to  another  implica- 
tion. Under  these  terms  the  seller  agrees  to  take  all  risks 
as  well  as  pay  all  costs  until  the  goods  are  on  the  vehicle  of 
transportation  at  the  indicated  place,  and  the  buyer  agrees 
to  take  all  subsequent  expenses  and  risks. 

F.  A.  S.  or  "free  along  side"  the  steamer  at  some  point 
of  shipment  or  transshipment,  signifies  that  the  seller  is  to 
deliver  the  wares  on  the  suitable  lighter  or  pier  along  side 
the  ship,  taking  expenses  and  risks  to  this  point,  the  bivyer 
carrying  them  thence  forward. 

C.  I.  F.  signifies  that  insurance  and  freight  are  payable 
by  the  seller  to  some  stipulated  point,  whether  an  inter- 
mediate place  or  the  place  of  ultimate  destination.  Under 
these  terms  delivery  from  seller  to  buyer  is  made  at  the 
initial  shipping  point,  and  the  carrier  becomes  the  agent  of 
the  buyer  and  not  of  the  seller,  so  that  the  risks  while  tin' 


336  FOREIGN  EXCHANGE 

goods  are  in  transit  are  assumed  b}r  the  buyer.  In  the 
formula  C.  I.  F.,  C.  means  not  incidental  costs  but  means  the 
cost  of  the  goods  themselves  or  the  bare  price.  The  price 
quoted  includes  this  and  also  the  insurance  and  the  freight 
charge.  "The  amount  of  money  named  in  the  contract  [of 
sale]  is  all  that  the  buyer  is  to  be  required  to  pay  for  the 
goods  themselves,  for  insuring  them  during  transportation, 
and  for  the  carrier's  freight  charges.  These  expenses  fall 
upon  the  seller,  all  others  on  the  buyer.  Delivery  is  not 
made  on  board,  but  at  the  warehouse  or  wherever  the 
goods  may  be  when  sold.  The  buyer  pays  for  taking 
them  to  the  cars  or  vessel.  He  pays  every  expense  not  in- 
cluded in  the  cost  of  the  goods  themselves,  or  in  their  in- 
surance and  actual  cost  of  carriage.  Established  usage  in 
certain  lines  has  decreed  that  the  seller  shall  bear  some 
minor  expenses  not  falling  strictly  under  any  one  of  these 
three  heads,  but  that  is  altogether  exceptional."  33  C.  F.  or 
C.  A.  F.  have  the  same  force  as  C.  I.  F.  except  that  they 
place  the  cost  of  insurance  during  transit  upon  the  buyer 
instead  of  the  seller 

The  purport  of  the  expression  "franco  domicile"  is  that 
the  wares  are  to  be  delivered  by  the  seller,  for  the  price 
named,  at  the  very  place  of  business  of  the  buyer  in  the  city 
of  destination.  No  terms  respecting  incidental  costs  could 
be  more  liberal  to  the  buyer.34 

33  Quoted  from  the  "Exporter's  Encyclopedia"  already  cited,  p.  117, 
edition  of  1914,  or  p.  221,  edition  of  1918-19.  For  the  fullest  dis- 
cussion of  what  we  may  call  "commercial  terms"  the  reader  would 
best  consult  a  legal  treatise  on  "Sales." 

34  According  to  W.  A.  Graham  Clark,  European  export  houses  that 
were  before  the  war  desirous  of  getting  a  foothold  in  the  cotton  busi- 
ness in  Turkey  would  sometimes  grant  the  terms  "franco  domicile." 
See  Special  Agents  Series  (Department  of  Commerce  and  Labor), 
No.  18,  "Cotton  Textile  Trade  in  the  Turkish  Empire,"  etc.,  Wash- 
ington, 1908,  p.  17.  The  following  is  quoted  from  another  number 
of  the  same  series:     "Far  more  satisfactory  results   [in   developing 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      337 

§  77.  Dealing  in  exchange  on  places  where  no  balance  is 
kept. — Heretofore,  when  we  have  supposed  a  bank  to  buy 
or  sell  bills  and  cables,  we  have  assumed  bills  and  cables 
payable  in  a  place,  or  at  .least  in  a  country,  where  the  bank 
has  a  balance  or  what  is  more  familiarly  known  as  a  deposit. 
Now  while  a  bank  would  find  it  a  great  convenience  to  keep 
such  an  account  in  any  city  in  bills  upon  which  it  conducts  a 
large  and  active  business,35  it  can  nevertheless  both  buy  and 
sell  exchange  on  a  place  or  country  where  it  does  not  main- 
tain a  deposit. 

We  can  distinguish  three  classes  of  such  transactions. 

I.  The  first  is  the  purchase  or  sale  of  exchange  by  a  cen- 
trally located  bank  upon  a  place  where  it  has  a  depositing 
correspondent.  By  the  latter  we  mean  a  bank  which  keeps 
a  deposit  with  the  centrally  located  institution  but  does  not 
hold  a  deposit  from  it.  New  York  banks  have  deposits  from 
innumerable  lesser  interior  banks  without  carrying  deposits 
with  them.  The  same  statement  will  hold  generally  of  the 
relations  of  the  greater  London  banks  to  foreign  establish- 
ments scattered  over  the  world.  If  a  man  in  London,  who 
wished  to  make  payment  to  one  in  New  York,  approached 
his  bank  for  a  draft  on  the  latter  city,  the  bank  might  be 
unable  to  draw  for  him  a  check  against  a  balance.  It  might 
advise  its  customer  to  buy  and  send  a  sterling  draft  to  his 
American    creditor    or    friend,    nevertheless    it    can,    if    it 

American  cotton  trade]  would  be  obtained  if  prices  were  quoted 
c.i.f.  a  Turkish  port,  as  is  the  rule  with  the  European  manufac- 
turers. It  is  even  possible  to  quote  franco  domicile,  as  the  Italians 
sometimes  do,  because  the  Turkish  tariff  on  all  imports  is  uniformly 
11%  of  the  invoice  value.  It  is  far  more  satisfactory  to  the  dealer 
here  to  know  just  what  the  goods  will  cost  him  landed  at  his  door." 
Special  Agents  Series,  No.  54,  "Cotton  Goods  in  Turkey."  by  Ralph 
M.  Odell,  Tart  I.   1912,  p.  21. 

3r'  If  the  business  is  very  large  indeed  it  may  make  advisable  the 
establishmenl  of  a  branch  or  agency. 


FOREIGN  EXCHANGE 

chooses,  sell  a  demand  draft  on  New  York.  It  can  draw  on 
some  bank  in  that  city  from  which  it  holds  a  deposit,  or 
which  is,  in  other  words,  one  of  its  depositing  correspond- 
ents. It  will  send  advice  to  this  correspondent  requesting 
that  it  pay  the  draft  when  presented,  and  will  suggest  means 
whereby  the  correspondent  may  reimburse  itself,  unless 
these  means  are  already  understood.  There  is  more  than 
one  method  possible  for  accomplishing  the  object.  Not  to 
go  too  far  into  detail,  one  plan  would  be  for  the  bank  at 
New  York  to  draw  a  draft  on  the  London  bank  in  a  suffi- 
cient sum  to  sell  (at  the  local  rate  for  this  class  of  exchange) 
for  the  dollars  it  has  paid  out  on  the  London  bank's  draft 
plus  its  charges,  if  any,  for  its  service.  This  second  draft, 
or  reimbursement  draft,  the  London  banker  would  pay 
without  deduction  from  the  New  York  bank's  deposit,  and 
so  reimbursement  would  be  effected.  Again  the  New  York 
bank  might  omit  to  sell  the  reimbursement  draft  and  instead 
merely  send  advice  by  mail  to  the  London  bank  to  credit 
its  (the  New  York  bank's)  balance  with  the  same  amount 
of  sterling  for  which  this  draft  would  have  been  drawn, 
the  credit  to  be  entered  on  the  arrival  of  the  advice.  This 
change  would  be  from  the  standpoint  of  the  London  bank 
a  matter  of  indifference,36  but  would  give  the  New  York 
bank  its  reimbursement  in  the  shape  of  London  funds  in- 
stead of  New  York  funds.  These  London  funds  simply  be- 
come merged  in  the  general  credit  against  which  the  New 
York  bank  can  sell  sight  sterling  at  any  time.  Under  either 
variation  of  the  plan  of  reimbursement  here  outlined,  the 
centrally  located  establishment  (the  London  bank  in  this 
case)  gains  the  use  of  the  sum  for  which  it  sold  its  original 
draft,  for  a  period  at  least  double  the  mail  time  between 
itself  and  the  city  on  wrhich  it  drew. 

36  Under  either  variation  it  pays  the  same  amount  of  sterling 
on  the  same  day,  namely  the  day  of  the  arrival  of  return  mail  from 
New  York. 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      339 

Speaking  of  the  general  case,  namely  draft  by  a  bank 
upon  its  depositing  correspondent  in  a  foreign  country,  the 
method  of  reimbursement  to  be  arranged  between  the  two 
institutions  is  a  problem  of  two  principal  elements,  (1)  the 
time  of  the  act  of  reimbursement,  and  (2)  the  rate  of  ex- 
change at  which  it  takes  place.  To  give  merely  one  further 
example  to  bring  out  the  meaning  of  these  elements,  it 
would  be  a  conceivable  method  for  the  London  bank  to  re- 
imburse the  New  York  correspondent  by  crediting  its  bal- 
ance (1)  on  the  day  when  the  London  bank  sold  the  draft 
on  New  York  and  (2)  at  the  rate  of  exchange  between 
dollars  and  pounds  then  current  either  (a)  in  the  London 
market  or  (b)  in  the  New  York  market.  The  reader  will 
perceive  that  the  timing  of  the  act  of  reimbursement  deter- 
mines which  of  the  banks  enjoys  the  temporary  use  of 
funds,  or  a  hidden  interest  gain,  on  account  of  the  whole 
operation,  and  for  what  period. 

If  the  London  bank  were  called  upon  to  collect  a  draft 
drawn  on  some  one  in  or  near  New  York  (whether  or  not 
it  had  bought  the  instrument),  it  could  again  make  use 
of  the  facilities  of  its  depositing  correspondent.  It  could 
ask  the  latter  to  obtain  payment  and  return  the  proceeds 
by  remitting  a  draft  on  London,  taking  out  the  charges 
in  dollars  and  cents  before  buying  this  sterling  return 
draft  with  the  dollars  collected.  If  the  New  York  bank 
itself  draws  the  return  draft  on  the  London  bank  itself 
and  payable  to  the  London  bank  itself,  the  whole  matter 
is  settled.  In  the  end  the  London  bank  reimburses  itself 
by  making  a  deduction  from  the  sterling  balance  it  owes 
the  New  York  bank,  and  the  latter  has  collected  and  kept 
the  dollars  paid  by  the  drawee  of  the  original  draft  on 
New  York. 

II.  The  second  case  of  the  sale  of  exchange  on  a  place 
where  the  drawer  has  no  balance  is  one  where  a  depositing 


340  FOREIGN  EXCHANGE 

correspondent  of  some  centrally  located  institution  draws 
upon  a  fellow  depositing  correspondent  of  the  same  institu- 
tion, but  a  fellow  in  a  foreign  land.  Suppose  bank  A  in 
Africa  or  Asia  or  South  America  and  bank  B  in  the  United 
States  both  cany  balances  with  Lloyds'  Bank  of  London. 
Either  one  can  draw  on  the  other  and  request  payment  and 
provide  a  fairly  convenient  plan  of  reimbursement,  and 
either  one  can  ask  the  other  to  make  a  collection  for  it.  For 
one  example,  suppose  that  bank  A  in  Bombay  was  pressed 
to  sell  a  draft  (a  sight  draft  of  course)  on  New  York  where 
bank  B  is  located.  It  could  draw  on  B,  advise  it  of  the  act, 
request  honor  of  the  instrument,  and  propose  reimburse- 
ment by  B's  drawing  enough  sight  sterling  on  Lloyds' 
Bank  to  sell  for  the  dollars  it  has  paid  out  plus  its  charges. 
This  sight  sterling  would  of  course  be  payable  at  Lloyds' 
Bank  not  from  the  balance  of  bank  B  but  from  that  of 
bank  A  of  Bombay,  and  bank  A  would  so  advise  Lloyds'. 
Thus  the  bank  in  Bombay  sells  a  dollar  draft  for  rupees, 
and  makes  a  payment  against  this  operation  by  submitting 
to  a  transfer  of  some  of  its  sterling  credit  in  London  to 
the  American  bank  on  which  it  has  drawn.  It  can  if  it 
desires  turn  the  rupees  upon  their  receipt  into  sight  sterling 
drafts  bought  in  Bombay  to  forward  to  London.  It  takes 
one  risk  of  exchange,  the  risk  as  to  the  position  of  the 
sight  rate  in  New  York  on  London  on  the  day  when  the 
New  York  bank  draws  the  reimbursement  sterling  draft. 
In  this  kind  of  business,  which  naturally  has  a  sporadic 
character,  B,  the  seller  of  the  unusual  class  of  exchange, 
should  make  the  rate  quoted  cover  the  contingencies  of  the 
case.  The  bank  in  New  York  pays  out  dollars  to  honor  the 
draft  drawn  on  it,  and  gets  the  dollars  back  immediately 
by  a  sale  of  a  sight  sterling.37 

37  If  it  preferred  such  bank  could  of  course  deposit  this  sterling  to 
its  own  credit  in  London  instead  of  selling  it  for  dollars  in  New 
York. 


DEALINGS  OF  A  MORE  INVOLVED  CHARACTER      341 

III.  The  third  case  of  the  sale  of  exchange  on  a  place 
where  the  drawer  has  no  balance  is  exemplified  by  the  offer- 
ing of  sterling  and  other  foreign  bills  by  many  of  the  lesser 
interior  banks  in  the  United  States.  Suppose  that  A  who 
resides  in  some  smaller  city  or  town  has  need  of  a  sterling 
bill  for  £50,  perhaps  to  pay  for  an  order  of  books.  It  is 
entirely  possible  his  local  bank  will  be  in  a  position  to 
supply  him  even  though  it  has  no  deposit  in  London,  or 
elsewhere  abroad.  It  sells  him,  we  may  suppose,  a  draft  of 
its  own  drawing  on  the  London  County  Westminster  and 
Parr's  Bank,  and  charges  a  rate  something  above  open 
market  rates  in  the  great  cities.  It  has  an  arrangement 
with  some  greater  American  bank  (or  with  some  exchange 
house)  one  in  New  York  perhaps,  which  makes  this  feasible. 
This  New  York  bank  is  one  which  has  a  deposit  with  the 
London  County  and  Westminster.  Without  much  of  the 
detail,  the  plan  is  this :  The  local  bank  draws  the  draft. 
This  instrument  will  look  almost  like  a  normal  draft  on  a 
European  bank  but  will  in  fact  be  on  a  peculiar  form,  which 
serves  to  identify  it  immediately  at  the  drawee  bank  for 
what  it  is.  The  drawing  bank  quickly  starts  an  advice  on 
its  way  to  the  New  York  bank  asking  it  to  advise  the  Lon- 
don County  Westminster  and  Parr's  to  honor  the  draft 
and  reimburse  itself  from  its  (the  New  York  bank's)  bal- 
ance. The  New  York  bank  probably  carries  a  deposit  from 
our  local  bank,  and  will  be  authorized  to  collect  from  this 
the  number  of  dollars  due  for  the  sterling  which  it  has 
virtually  sold  the  lesser  bank  and  for  its  commission  or 
charges.  Or  the  local  bank  may  remit  it  this  number  of 
dollars  in  New  York  exchange  along  with  the  advice.  The 
banks  act  quickly  to  insure  the  arrival  of  advices  in  London 
as  early  as  the  sterling  draft.  It  all  conies  to  this:  Mr. 
A  pays  his  local  bank  dollars,  it  pays  a  New  York  hank 
dollars,  the  latter  pays  the  London  hank'  pounds  (out  of 
its  balance  with  this  bank),  and   the   London   bank    pays 


342  FOREIGN  EXCHANGE 

the  pounds  due  on  the  draft  to  the  holder  thereof.  Banks 
and  dealers  that  provide  interior  banks  with  the  facilities 
just  described,  are  sometimes  called  "exchange  jobbers," 
and  this  particular  branch  of  business  is  called  "exchange 
jobbing." 


CHAPTER  XI 
INVESTMENT  IN  EXCHANGE 

§  78.  Exchange  investment,  borrowing,  and  speculation. — 
At  this  point  we  begin  the  discussion  of  a  group  of  opera- 
tions which  do  not  arise  out  of  the  export  and  import 
of  goods  or  securities  but  which  are  engaged  in  by  bankers 
and  exchange  dealers  without  any  object  of  effecting  com- 
mercial settlements.  Of  these  operations  there  are  four 
principal  kinds,  (1)  investments  in  exchange,  (2)  borrow- 
ing by  means  of  exchange,  (3)  speculation  in  exchange,  and 
(4)  arbitrage  in  exchange.  A  chapter  will  be  given  to 
each. 

Regular  long-term  international  borrowing  and  lending, 
accomplished  chiefly  by  the  international  sale  of  bonds  and 
stocks,  give  rise  of  course  to  vast  numbers  of  transactions 
in  exchange.  Settlement  must  be  made  by  importers  with 
the  exporters  of  such  securities,  for  their  original  sale  prices, 
and  periodically  the  payment  of  interest  charges  and  divi- 
dends from  the  one  country  to  the  other  will  force  resort 
to  the  exchanges.  But  when  we  come  now  to  speak  of 
investment  in  exchange  and  borrowing  by  means  of  ex- 
change, we  do  not  have  reference  to  international  invest- 
ments or  loans  of  capital  effected  by  the  transfer  of  long- 
term  securities,  even  though  these  have  their  exchange  rela- 
tions. We  have  in  mind  certain  entirely  distinct  and 
technical  operations  in  bills  of  exchange  themselves,  such 
on  the  one  hand  as  the  purchase  of  a  long  foreign  bill  to 
be  held  till  maturity  instead  of  being  discounted  in  the 
foreign  money  market,  and  such  on  the  other  hand  as  the 

343 


344  FOREIGN  EXCHANGE 

drawing  and  sale  of  a  banker's  long  bill  on  a  foreign  banker 
as  a  means  of  gaining  the  benefit  of  a  virtual  loan  of  funds 
for  the  term  of  the  draft. 

Speculation  in  foreign  exchange  is  a  technical  possibility 
and  is  much  practiced  by  certain  types  of  dealers.  It 
bears  some  fundamental  resemblances  to  speculation  in 
stocks  or  commodities,  but  is  a  subject  requiring  a  special 
explanation  which  it  shall  be  our  endeavor  to  give  in  Chap- 
ter XIII  of  this  book.  Foreign  exchange  investment,  bor- 
rowing, and  speculation  are  intimately  related  themes.  The 
first  two  always  involve  a  speculation  on  the  future  course 
of  the  sight  rate  of  exchange.  The  one  taking  such  a 
speculation  may  cancel  it  or  neutralize  it  by  a  proceeding 
which  is  commonly  known  as  "hedging";  this  does  not 
mean  that  the  speculation  is  not  involved,  but  rather  that, 
being  involved,  it  can  by  a  special  device  be  neutralized. 
(Compare  the  explanation  of  hedging  in  §  91  to  follow.) 
Investment  and  borrowing  are  related  to  each  other  in  that 
both  are  due  to  or  are  occasioned  by  a  difference  between 
discount  rates  at  home  and  abroad.  But  the  two  are  oppo- 
site in  this  respect,  that  investment  in  exchange  tends  to 
be  produced  by  lower  money  rates  at  home,  while  borrow- 
ing, or  the  drawing  of  finance  bills,  tends  to  be  produced 
by  higher  money  rates  at  home.  The  two  are  opposite 
also  in  respect  to  the  immediate  or  contemporary  effect 
they  tend  to  work  upon  the  sight  rate.  'Exchange  invest- 
ment on  our  part  tends  at  the  time  when  the  investments 
are  taking  place  to  raise  our  sight  rate  of  exchange  on  the 
foreign  country,  and  so  far  as  it  goes,  tends  thus  to  bring 
about  gold  exports,  whereas  exchange  borrowing  on  our 
part  tends  towards  the  reverse  effects,  a  lowering  of  the 
sight  rate  and  a  production  of  gold  imports, 

§  79.  The  method  of  investment. — Investment  in  foreign 
exchange,  or  the  holding  for  a  period  of  time  of  a  long 
foreign  bill  that  has  been  bought  and  paid  for,  is  the  op- 


INVESTMENT  IN  EXCHANGE  345 

posite  of  the  earliest  possible  discount  of  the  instrument 
in  the  money  market  abroad  where  it  is  payable.  The  act 
is  regarded  as  one  of  investment  because  it  involves  the 
making  of  an  outlay  and  the  awaiting  of  a  deferred  return. 
It  is  an  exchange  of  present  money  for  future  money. 
"We  have  now  become  quite  familiar  with  the  fact  that 
if  a  long  bill  is  to  be  discounted  on  its  arrival  abroad,  a 
return  can  be  had  from  it  at  home  on  the  very  day  of  its 
purchase  (or  at  the  worst  perhaps,  on  the  next  business 
day)  by  an  immediate  sale  of  sight  drafts  against  the  pro- 
ceeds of  the  discount  as  cover.  Withholding  the  bill  from 
discount  means  the  postponement  of  this  return.  The 
whole  operation  becomes  an  investment  because  a  period 
intervenes  between  outlay  and  return.  For  this  period  a 
certain  amount  of  capital  is,  as  the  business  expression 
goes,  employed  in  the  bill.  On  this  capital  the  banker 
expects  to  make,  and  normally  does  make,  a  gain — a  gain 
which  is,  of  course  interest.  Investment  cannot  take  place 
in  sight  bills  or  cable  transfers,  because  no  gain  can  be 
realized  from  the  postponement  of  their  conversion  into 
cash  abroad. 

Sometimes  the  remittance  of  funds  to  a  foreign  country 
to  be  put  out  there  in  the  purchase  of  bonds  or  notes,  or 
in  the  making  of  short-term  loans  or  advances,  is  referred 
to  as  an  investment  in  foreign  exchange.  It  is  true,  with 
the  exception  of  a  "dollar"  loan  made  abroad,  there  is 
here  an  investment  in  an  obligation  to  pay  foreign  money, 
and  therefore  the  operation  involves  a  risk  of  exchange, 
i.e.,  a  chance  taken  with  respect  to  the  rate  of  conversion 
of  the  recovered  foreign  funds  back  into  home  money ;  but 
there  is  not  technically,  and  properly  speaking,  an  invest- 
ment in  foreign  exchange.  The  latter  means  an  investment 
in  an  instrument  that  is  itself  a  piece  of  foreign  exchange, 
a  bill.  The  investment  in  an  obligation  payable  in  foreign 
money,  but  not  itself  a  foreign  bill  of  exchange,  is  similar 


:U6  FOREIGN  EXCHANGE 

to  this,  but  not  identical  with  it.  The  transaction  is  best 
thought  of  as  a  foreign  loan  with  the  risk  of  exchange  taken 
by  the  lender. 

Practically  all  foreign  bills,  sight  or  long,  are  drawn 
in  two  or  more  copies,  the  original  reason  being  to  make 
it  possible  for  the  sake  of  safety  to  hold  one  copy  while 
transmitting  another,  or  to  forward  different  copies  by 
separate  mails.  But  in  the  case  of  an  investment  in  a  bill, 
the  first  and  second  of  exchange  are  put  to  distinct  tech- 
nical uses.1  The  first  will  be  sent  abroad  for  acceptance 
only.  The  banker  will  omit  to  indorse  this  copy  and  will 
mark  it  "for  acceptance  only,"  which  will  signify  that, 
while  this  acknowledgment  by  the  drawee  is  to  be  procured, 
the  bill  is  not  to  be  discounted  in  the  money  market  but  is 
to  be  held  by  the  correspondent  subject  to  the  orders  of 
the  remitting  banker.  If  the  drawee  intends  to  honor 
the  bill  he  will  accept  this  first  of  exchange  (receiving 
the  documents  if  they  are  deliverable  against  acceptance), 
but  when  he  comes  to  make  payment  at  maturity  he  will 
expect  the  indorsed  second  to  be  surrendered  to  him  along 
with  the  unindorsed  but  accepted  first,  the  two  copies  to- 
gether constituting  the  completed  bill.  Meanwhile,  the  bank 
that  has  purchased  the  bill,  and  is  investing  in  it,  will  hold 
the  second  of  exchange  in  its  portfolio  as  the  tangible 
representative  of  the  asset  which  it  is  carrying,  until  the 
time  when  it  decides  to  realize  upon  it  by  sale  at  home  or 
discount  abroad,  or,  at  the  latest,  until  the  time  when  the 
instrument  must  be  forwarded  to  reach  destination  by  the 
date  of  maturity.  When  transmitted,  this  second  will  be 
indorsed,  and  should  the  owner  desire  to  discount  the  bill 
at  any  time  with  any  dealer  abroad,  it  is  understood  that 
the  latter  will  have  a  right  to  procure  the  accepted  first 
from  the  correspondent  holding  it,  upon  making  a  demand 

i  According  to  Margraff.  See  his  "International  Exchange,"  pp. 
61-2 


INVESTMENT  IN  EXCHANGE  347 

and  showing  the  indorsed  second.  Thus  the  foreign  pur- 
chaser will  come  into  possession  of  the  completed  bill  which 
he  will  need  to  present  to  the  acceptor  for  payment  at 
maturity. 

The  fact  that  a  banker  purchasing  a  foreign  bill  intends 
to  invest  in  it,  instead  of  discounting  it  for  immediate  for- 
eign cash,  does  not  in  the  least  reduce  his  motive  to  obtain 
the  earliest  possible  acceptance.  There  is  in  the  first  place 
what  we  might  call  the  legal  reason  for  promptness.  If 
the  bill  is  of  such  a  character  that  presentment  for  accept- 
ance is  required  in  order  to  bind  the  drawer  in  his  condi- 
tional or  secondary  liability2  (the  ordinary  form  of  long 
bill  payable  a  designated  period  after  sight  is  of  this  char- 
acter), then  the  presentment  for  acceptance  must  be  made 
with  reasonable  promptness  if  the  drawer  (or  an  indorser,  if 
any,  prior  to  the  owner-bank)  is  not  to  escape  his  liability.3 
There  is  in  the  second  place  the  financial  reason  for  prompt- 
ness. Every  day's  postponement  of  acceptance  means  a 
day's  postponement  of  the  date  of  maturity,4  and  this  post- 
ponement produces  no  increase  in  the  amount  due  at  ma- 
turity. Hence,  there  being  no  compensation  in  the  nature 
of  interest  for  any  delay,  postponement  becomes  financially 
bad. 

§  80.  Computing  the  rate  of  interest  received. — The  data 
required  to  compute  the  rate  of  interest  received  from  an 
investment  in  exchange  comprise 

(1)   the  amount  of  home  money  invested  in  the  bill,  or 
what  we  have  usually  called  the  outlay, 

2  Compare  §  12. 

3  But  the  drawer  or  indorser  does  not  escape  if  he  makes  a  special 
agreement  waiving  his  rights  in  regard  to  acceptance  or  promptness 
of  acceptance. 

*To  this  there  is  an  exception  in  the  case  of  bills  drawn  payable 
at  so  and  so  many  days  after  date  (instead  of  Bight)  or  drawn 
payable  at  a  named  future  dale,  but  both  these  forms  are  com- 
partively  rare. 


.its  FOREIGN  EXCHANGE 

(2)  the  amount  of  home  money  in  the  end  realized  from 

the  bill,  or  the  return,  and 

(3)  the  time  intervening  between  outlay  and  return. 

It  will  be  natural  to  jump  to  the  conclusion  that  the  invest- 
ing banker's  outlay  consists  of  the  price  he  paid  for  the 
bill.  It  is  true  that  this  is  an  outlay,  but  strictly  speak- 
ing it  is  not  the  outlay  in  the  case.  The  true  outlay  is 
the  amount  the  banker  could  realize  from  the  bill  on  the 
very  day  of  purchase  by  selling  sight  drafts  against  it 
and  discounting  it  on  its  arrival  abroad.  If,  for  instance, 
the  banker  has  paid  $48,020  for  a  60  days'  sight  bill  on 
London  for  £10,000,  but  could  immediately  realize  $48,045 
from  it  by  the  method  of  discounting  it  on  arrival  abroad, 
the  latter  figure,  namely,  the  $48,045,  is  truly  the  amount 
invested,  if  the  banker  elects  the  alternative  of  investment. 
That  is  to  say,  he  makes  an  investment  of  $48,045  of  pres- 
ent money  by  foregoing  this  sum.  This  is  the  sum  he  gives 
up  for  the  sake  of  the  future  return,  and  the  wisdom  of  the 
investment  depends  upon  the  rate  per  cent,  which  the  re- 
turn yields  upon  this  sum  considered  as  the  outlay.  The 
$25  by  which  this  exceeds  the  price  paid  for  the  bill  is  a 
profit  derived  from  the  purchase,  which  the  banker  gets 
whether  he  invests  or  not,  and  it  is  not,  on  correct  principles 
of  accounting,  a  part  of  the  gain  or  interest  received  from 
the  investment  itself. 

To  obtain  an  illustration,  let  us  assume  the  following 
facts,  and  compute  the  interest  rate : 

July  1      N.  Y.  banker  purchases  and  invests  in  a  60 
days'  bill  for  £10,000,  paying  $48,020  for  it. 

"  Rate  for  bankers'  sight  sterling 4.85 

"  Arrival  discount  rate  quoted  in  London 5% 

"  Rate  of  interest  for  demand  loans  in  New  York  3% 

July  9      Acceptance  of  bill  by  London  drawee. 
Sept.  10  Maturity  date,  as  fixed  by  this  acceptance. 
(3  days  of  grace  being  allowed). 


INVESTMENT  IN  EXCHANGE  349 

We  suppose,  further,  that  the  investment  continues  till 
the  maturity  of  the  bill,  though,  as  we  understand,  it  might 
be  terminated  at  any  intermediate  date. 

Sept.  2  Assumed  earliest  date  on  which  sight  drafts  can 
be  sold  to  be  covered 5  by  this  acceptance 
which  matures  Sept.  10. 

Sept.  2  Rate  for  sight  sterling  in  New  York 4.85 

Net  Cash  Yield  of  Bill  in  Dollars  if  Discounted 
Forthwith  in  London 

On  the  principle  just  explained,  to  find  the  theoretically  correct 
amount  invested  we  must  find  what  could  be  realized  from  this  bill  in 
immediate  cash  by  discounting  it  abroad  on  arrival.  We  proceed  as 
follows:6 

Net  proceeds  of  this  discount  in  London  on  July  9th. 

£10,000  less  63  days'  discount  at  5%  7 £9,913.7 

Tax  and  commission  deducted  by  correspondent. ...  7.5 

Net  yield  of  bill  to  London  balance,  July  9 9,906.2 

Dollar  receipts  from  sale  of  sight  sterling  against  this. 
Sight  drafts  for  £9,906.2  sold  on  July  1st,  at  4.85, 

yield  in  N.  Y $48,045.07 

Dollar  Return  from  Bill  at  End  of  Investment 
Period 

Maturity  value  of  the  bill  in  sterling  in  London 
Payment  received  from  the  acceptor  on  Sept.  10 ... .  £10,000 
Tax  and  commission   7.5 


Sterling  maturity  value 9,992.5 

•r>  That  is,  to  be  paid  for  in  London  out  of  the  receipts  from  the 
maturing  acceptance. 
«  Compare  §§  64  and  65. 
7  The  year  is  taken  as  365  days  throughout  this  example. 


350  I'OK'KICN    EXCHANGE 

Dollar  receipt*  from  sale  of  sight  sterling  against  this 
Sight  drafts  for  £9,992.5  sold  on  Sept.  2d,  at  4.85. . .  $48,463.62 

SUMMARY 

July  1st  Amount  invested  (i.e.,  cash  foregone) $48,045.07 

Sept.  2d  Amount  returned  from  investment   48,463.62 

Difference,  or  interest  gain  for  63  days 418.55 

This  is  interest  on  $48,045.07  at  the  rate  per  annum  of  5.05% 
As   a  discount  of  $48,463.62  this  is  at  the  rate  per 

annum  of 5      % 

This  computation  is  based  on  the  supposition  that  the  rate 
for  bankers'  sight  sterling  stands  at  the  same  figure  on 
Sept.  2d  as  on  July  1st,  namely  4.85.  This  is  very  much 
of  an  assumption.  The  effects  of  a  change  of  the  sight 
rate  during  the  period  of  the  investment  will  be  taken  up 
in  §  81.  But  the  computation  as  we  have  it  before  us  is 
an  illustration  of  the  fact  that,  if  the  sight  rate  remains 
unchanged,  the  investment  earns  the  foreign  money  rate 
applicable  to  the  bill  in  which  the  investment  is  made.  This 
rate  is  a  discount  rate,  and  in  the  case  in  hand  is  5%.  The 
interest  made  in  the  investment  turns  out  to  be  at  the  rate 
of  5.05%  per  annum,  but  this  is  the  mathematical  equiva- 
lent of  a  discount  rate  of  5%.8 

§  81.  The  speculation  on  the  sight  rate  of  exchange. — 
Since  the  dollar  outcome  from  the  investment  depends  upon 
the  sight  rate  of  exchange  on  the  day  of  the  sale  (or  assumed 

s  The  gain  in  the  example  will  not  figure  to  a  discount  at  pre- 
cisely 5%.  A  slight  deviation  from  this  rate  is  produced  by  the 
manner  in  which  we  have  found  it  most  convenient  to  introduce  the 
tax  and  commission  charges  of  £7.5.  For  our  purposes  this  matter 
is  not  worth  the  time  it  would  take  to  ventilate  it.  If  these  charges 
are  removed,  or  disregarded,  the  discount  gain  from  the  investment 
on  this  side  of  the  water  works  out  to  precisely  5%.  On  the  sub- 
ject of  the  relation  of  the  discount  to  the  interest  rate,  compare 
§§  14  and  17. 


INVESTMENT  IN  EXCHANGE 


351 


sale9)  of  the  investing  banker's  demand  drafts,  the  rate 
of  interest  gained  in  the  operation  is  necessarily  dependent 
upon  this  same  rate  of  exchange.  The  character  of  this 
dependence  is  made  plain  in  the  table  beneath. 

RATE  OF  INTEREST  REALIZED  FROM  AN  INVEST- 
MENT IN  A  SIXTY  DAYS'  BILL 


Dollars    Invested,  Sight  Rate 

sight  rate  at  Time  of 
being  at  4.85  Realizing 
at  time   of   the  on  the 

investment  Investment 


$48,045.07 
48,045.07 
48,045.07 


4.84 
4.85 
4.86 


Total 

Amount  of 

Rate  of 

Dollars 

Interest 

Interest 

Realized 

Yielded 

Yielded 

by  the 

Investment 

$48,363.70 

$318.63 

3.83% 

48,463.62 

418.55 

5.05% 

48,563.54 

518.47 

6.25% 

If  the  rate  of  exchange  happened  to  be  invariable  we 
could  lay  down  the  rule  that  an  investment  in  a  long  foreign 
bill  will  yield  the  foreign  money  rate  applicable  to  this  bill 
at  the  time  of  its  arrival  abroad.  This  is  the  London  dis- 
count rate  of  5%  assumed  in  the  example  in  the  preceding 
section.  But  the  rate  of  exchange  is  by  no  means  invari- 
able. The  higher  it  turns  out  to  be  the  higher  will  be  the 
interest  yield,  and  vice  versa.     With  the  exchange  rate  at 

3  If  the  banker  omits  to  make  this  sale  and  so  draw  back  home 
the  sterling  proceeds  of  the  bill,  he  allows  these  proceeds  to  become 
a  net  addition  to  his  foreign  funds.  But  this  supposition  does  not 
necessitate  a  change  in  the  method  of  computing  the  rate  of  inter- 
est in  the  investment.  The  net  addition  to  the  foreign  funds  in 
this  case  comes  without  a  contemporary  expenditure  of  dollars  for 
the  purchase  of  sight  exchange,  an  expenditure  which  would  otherwise 
be  required  to  produce  the  addition.  This  saving  of  dollars  is  the 
true  theoretical  return  upon  the  investment.  In  amount  it  is  the 
number  of  dollars  needed  to  buy  sight  pounds  in  the  open  market 
equal  to  the  net  maturity  value  of  the  long  bill.  Bui  this  is  the  same 
as  the  number  of  dollars  taken  as  (lie  outcome  in  the  computation 
in  the  text.  In  sum,  the  outcome  from  the  investment  is  the  aum 
ber  of  dollars  equivalent  to  the  proceeds  from  the  long  bill  in  pounds, 
at  the  sight  rate  of  exchange  whether  or  not  these  proceeds  are  in 
fact  drawn  back  into  dollars  by  the  banker. 


352  FOREIGN  EXCHANGE 

4.84  at  the  end  of  the  investment  period,  the  table  shows 
the  interest  yield  to  be  only  about  3.8%,  but  with  exchange 
at  4.87  the  yield  will  be  about  7.5%.  Yet  more  extensive 
variations  in  this  figure  would  be  produced  if  we  took  into 
account  different  rates  of  exchange  at  the  beginning  of  the 
investment  period.  Thus,  if  the  exchange  rate  were  4.87 
at  t lie  beginning  of  the  period,  and  4.84  at  the  end,  the 
interest  rate  gained  in  the  investment  under  the  conditions 
of  our  example  would  be  less  than  Vh.%  per  annum.  We 
hasten  to  state  that  investment  would  be  most  unlikely 
with  the  sight  rate  so  high  as  4.87,  precisely  because 
the  speculation  on  this  rate  would  then  be  so  distinctly 
unfavorable. 

By  way  of  summary:  the  first  circumstance  tending  to 
produce  investment  in  long  sterling  bills  is  a  higher  money 
rate  in  London  than  in  New  York.  Unless  the  associated 
speculation  on  the  rate  of  exchange  seems  unpropitious,  the 
banker  is  attracted  to  this  investment  because  he  bids  fair 
to  make  such  funds  as  he  places  in  long  sterling  bills  earn 
a  higher  rate  of  interest  than  if  employed  in  equally  liquid 
and  secure  advances  at  home.  Stated  in  another  way,  the 
existence  of  a  higher  discount  rate  in  London  tends  to  dis- 
suade our  bankers  from  discounting  their  long  sterling 
bills  there,  which  means  they  invest  in  them.  The  second 
circumstance  tending  to  produce  this  investment  is  a  low 
existing  sight  rate  of  exchange  in  our  country  on  London. 
The  lower  this  rate  at  the  time  of  the  investment  the  more 
attractive  the  speculation  upon  it  which  is  involved  in  the 
investment,  because  the  greater  the  chances  that  it  will  be 
as  high,  if  not  higher,  at  the  expiration  of  the  investment. 
Often  the  near  future  of  the  rate  of  exchange  seems  meas- 
urably predictable  to  the  banker  and  dealer,  and  their  dis- 
position toward  investment  will  be  in  large  degree  deter- 
mined by  their  prognostications  on  this  subject.  The  little 
chart  beneath  is  self-explanatory. 


INVESTMENT  IN  EXCHANGE  353 

INVESTMENT  CONDITIONS 

(Normal  times  assumed:  i.e.,  limits  of  fluctuation  of  sight  sterling 
about  4.84  and  4.88) 

Very  favorable  to  investment  Very  unfavorable 

London    money    rate    say    5%  London    money    rate    say    3% 

while  New  York  money  rate  while  New  York  money  rate 

is  3%  is  5% 

Sight  sterling  in  New  York  at  Sight  sterling  in  New  York  at 

4.84  with  indications  of  a  rise  4.88  with  indications  that  it 

due  in  the  near  future  will  fall 

The  causes  of  the  high  discount  rate  or  tight  money 
market  in  the  foreign  country  should,  of  course,  be  scruti- 
nized by  the  banker  who  has  in  contemplation  the  purchase 
of  long  bills  on  that  country  for  investment.  In  his 
"International  Exchange"  (page  60),  Margraff  warns 
against  investment  on  the  basis  of  a  high  discount  rate 
produced  by  the  danger  of  financial  or  economic  disturb- 
ances, as  contrasted  with  one  produced  by  brisk  commerce. 
During  the  panic  of  1866,  Paris  bankers  refused  to  invest 
in  long  sterling  bills  when  the  Bank  of  England  rate 
stood  at  10%  and  the  open  London  rates  were  corre- 
spondingly high.  Such  of  these  bills  as  the  French  dealers 
in  exchange  purchased,  they  discounted  immediately  in 
London,  despite  the  excessive  discounts  taken  out  there. 
This  was  due  to  distrust  of  London  conditions.  This  dis- 
trust disappeared  when  the  Bank  of  England  finally  re- 
duced its  rates  towards  the  normal  level  and  thus  "gave 
proof  of  its  own  returning  confidence."  10 

§  82.  Termination  of  investment  prior  to  maturity. — In 
any  times  approaching  the  normal  a  long  sterling  bill  of 
good  rating  can  be  sold  in  the  London  money  market,  at 
one  rate  of  discount  or  another,  on  any  day  within  the  life 
history  of  the  instrument.     (Documentary  payment  bills  as 

io  Compare  Clare's  "A  15  C  of  the   Foreign  Exchanges,"  pp.  97-9. 


354  FOREIGN  EXCHANGE 

a  class  are  not  discountable  under  English  banking  custom 
and  therefore  must  be  mentioned  as  an  exception  to  this 
statement.)11  In  buying  long  sterling  our  bankers  presum- 
ably confine  their  purchases  to  the  discountable  class  of 
bills  (except  again  for  such  documentary  payment  bills 
as  they  purchase),  and  take  the  inferior  class  for  collec- 
tion only.  Thus,  in  such  sterling  bills  as  they  hold  for 
investment  purposes,  they  have  assets  of  a  particularly 
liquid  character.12  If,  for  illustration,  a  New  York  banker 
has  a  90  days'  bill  on  London  which  he  has  been  holding 
for  perhaps  20  or  30  days,  and  he  decides  to  realize  upon 
it  at  the  present  moment,  he  may  put  it  in  to-day's  English 
mail  and  to-day  sell  sight  sterling  against  it,  thus  convert- 
ing it  forthwith  into  dollars.  Naturally,  the  desirability 
of  this  step  will  be  much  influenced  by  the  contemporary 
position  of  the  London  discount  rate  and  of  the  rate  for 
sight  sterling  in  New  York,  but  the  point  is  the  conversion 
can,  if  necessary,  be  made  at  any  time.  LTntil  recent  times 
this  liquidness  of  foreign  bills  distinguished  them  pretty 
sharply  from  the  other  domestic  commercial  paper  held  by 
American  banks.  While  this  distinction  is  doubtless  still 
of  consequence,  its  importance  is  on  a  fair  way  to  be  much 
reduced  b}-  reason  of  the  development  of  our  Federal  Re- 
serve Banks  and  the  accompanying  growth  and  alteration 
of  methods  in  our  home  money  market.  That  is  to  say, 
domestic  commercial  paper  eligible  for  rediscount  under 
our  new  law  and  practice,  becomes  like  the  long  foreign  bill 
in  liquidness. 

Its  own  special  and  individual  need  for  cash,  due  per- 
haps to  an  unusual  demand  from  its  depositors,  might 
lead  a  bank  to  abandon  its  investment  in  a  foreign  bill 
before  the  instrument  has  had  a  chance  to  reach  maturity. 

ii  Compare  §§  67  and  94. 

12  Other  long  foreign  bills  than  sterling,  held  for  investment,  are 
also  presumably  subject  to  this  observation. 


INVESTMENT  IN  EXCHANGE  355 

The  possibility  of  doing  this  is  what  we  have  in  mind  when 
we  speak  of  the  advantage  of  liquidness  which  is  possessed 
by  this  bill  as  an  asset.  But  a  sufficient  change  in  the 
governing  conditions  might  lead  to  a  general  termination 
of  investments  in  foreign  exchange  on  the  part  of  banking 
institutions,  not  because  any  of  the  banks  had  fallen  under 
a  compulsion  to  procure  cash  for  safety's  sake,  but  because 
this  termination  will  pay  in  dollars  and  cents. 

In  the  first  place  this  action  might  be  produced  by  a 
shift  in  the  relative  positions  of  the  London  and  the  New 
York  money  rates,  that  is,  by  a  sufficient  fall  of  the  former 
or  rise  of  the  latter.  In  the  illustration  in  the  preceding 
section  we  had  a  New  York  bank  purchase  and  invest  in 
a  60  days'  sterling  bill  on  July  1st,  when  the  London  dis- 
count rate  applicable  to  this  bill  was  at  5%,  and  the  New 
York  money  rate13  was  at  3%,  and  sight  sterling  in  New 
York  was  at  4.85.  By  way  of  modification  of  this  example 
assume  that  on  August  3d  the  London  discount  rate  has 
fallen  to  3^%,  and  that  the  London  correspondents  are 
quoting  this  same  figure  for  bills  to  arrive,  or  quoting  it 
as  a  forward  discount  rate,  and  assume  also  that  the  New 
York  money  rate  has  ascended  to  4%.  It  will  now  pay 
to  abandon  the  investment.  The  explanation  is,  in  brief, 
that  from  this  time  forward  a  continuation  of  the  invest- 
ment will  yield  only  314%  on  the  funds  which  may  be  re- 
covered from  it  and  which  may  be  employed  forthwith  at 
4%.  However,  lest  this  explanation,  sounding  almost  too 
simple,  should  be  subject  to  suspicion,  we  had  better  verify 
it  by  means  of  an  arithmetical  computation. 

i- This  means  (among  all  the  money  rates  of  New  York)  the  par 
ticular  rate  which  is  obtainable  from  an  employment  of  funds  judged 
by  the  bank  in  question  to  be  equally  desirable  with  investment 
in  long  sterling  from  the  standpoint  of  liquidness  and  security; 
in  general  presumably  the  rate  on  call  or  short  loans  against  good 
collateral. 


356  FOREIGN  EXCHANGE 

On  August  3d,  then,  the  bill  is  started  to  London,  sight 
sterling  being  sold  against  it  on  this  date,  and  it  arrives 
and  is  discounted,  we  may  suppose,  on  August  11th.  We 
need  first  to  know  the  dollar  proceeds  of  this  discount. 

DOLLAR  PROCEEDS  OF  DISCOUNT 

Maturity  value  of  bill,  due  Sept.  10 £10,000 

Less  30  days'  discount  at  31/£% £       28.77 

Discounted  present  worth  in  sterling £  9,971.23 

Less  tax  and  commission £  7.5 

Credit  available  for  sight  draft  on  August  3d £  9,963.73 

Yield  of  this  sold  out  at  $4.85  per  pound $48,324.09 

On  August  3d  the  bank  may  reason  as  follows :  If  we 
realize  on  this  bill  to-day  we  get  $48,324.09.  If  we  hold  it 
till  maturity,  and  the  sight  rate  remains  where  it  is  now, 
we  shall  realize  $48,463.62  on  September  2d,  or  30  days 
hence.  (Compare  illustration  in  preceding  section.) 
Therefore,  unless  we  care  to  speculate  upon  the  sight  rate's 
being  higher  and  thus  more  favorable  on  September  2d 
than  now,14  continuation  of  the  investment  will  be  equiva- 
lent to  giving  up  $48,324  of  to-day's  money  to  receive  a 
return  of  $48,463  thirty  days  hence.  But  this  particular 
exchange  of  present  for  future  money  yields  interest  at  only 
3%%  per  annum.  Therefore  we  had  better  terminate  the 
investment  and  employ  the  funds  derived  from  it  in  the 
home  market  at  4%. 

The  bank,  having  taken  this  step,  may  now  be  interested 
to  learn  what  rate  of  interest  it  has  secured  for  the  period 
during  which  it  did  invest  in  the  bill.  It  made  an  outlay 
of  $48,045  on  July  1st  (as  already  explained  on  pages  50-1), 
and  has  just  obtained  on  August  3d  a  return  of  $48,324. 

ii  But  see  §  91  below  on  the  possibility,  in  this  connection,  of  sale 
of  sight  exchange  for  future  delivery. 


INVESTMENT  IN  EXCHANGE  357 

This  gives  an  interest  gain  of  $279  received  for  the  em- 
ployment of  $-48,045  for  33  days,  making  the  interest  rate 
6.4%  per  annum.  Up  till  August  3d  the  investment  was 
excellent,  although  after  this  date  it  becomes  unprofitable. 
"When  the  investment  was  inaugurated  the  foreign  money 
rate  was  at  5%,  and  yet  the  outcome  has  been  a  higher  rate 
than  this,  namely,  6.4%.  This  outcome  has  been  made  pos- 
sible by  the  reduction  of  the  foreign  discount  rate  from 
5%  to  3V2%.  If  in  the  domestic  money  market  an  operator 
can  purchase  long  paper  under  a  5%  discount  rate,  and 
subsequently  rediscount  it  at  a  reduced  rate,  as  3V2%,  he 
will  alwa}7s  make  a  rate  of  interest  on  his  money,  for  the 
time  it  was  employed,  better  than  the  initial  discount  rate 
(compare  example  B  4  from  §  15,  on  page  47).  This  is 
essentially  what  our  bank,  investing  in  the  long  sterling 
bill,  has  done,  though  the  details  are  a  trifle  more  complex 
in  the  case  involving  foreign  exchange. 

It  was  stated  that  an  investment  in  a  long  foreign  bill 
might  be  abandoned  prior  to  maturity,  in  the  first  place 
because  of  a  shift  in  the  relative  positions  of  the  foreign 
and  the  local  money  rates.  It  remains  now  to  note  that 
independently  of  any  such  shifting,  a  sufficient  rise  in  the 
sight  rate  of  exchange  on  the  foreign  country  may  tempt 
the  banker  to  take  the  same  step  of  abandonment  of  the 
investment.  Thus,  amending  our  former  illustration  once 
more,  suppose  that  while  on  August  3d  the  London  discount 
rate  remains  at  5%,  where  it  was  at  the  inauguration  of 
the  investment,  sight  sterling  in  New  York  has  ascended 
to  4.88.  The  bank  will  be  under  strong  temptation  to  dis- 
count the  bill  to  arrive  (say  on  August  11th,  as  assumed 
before)  and  sell  demand  against  it  on  August  3d  at  4.88. 
If  it  were  certain  that  4.88  could  be  procured  for  demand 
at  the  maturity  of  the  investment,  the  reasons  for  con- 
tinuing, it  would  be  unimpaired;  but  let  us  suppose  the 
bank  feels  there  is  no  such  certainty  and  sells  out  on  the 


358  FOREIGK  EXCHANGE 

3d.     It  then  concludes  the  investment  with  an  interest  yield 
of  13%,  computed  as  shown  below. 

Outlay  in  dollars,  July  1st,  as  already  explained. . . .   $48,045 

Return  in  dollars,  August  3d,  or  33  days  later 

Credit  available  for  sight  draft  on  this 

date    £9,963.73 

(As  shown  in  last  preceding  example) 

£9,963.73  sold  at  4.88  bring  in $48,623 

Excess  of  return,  or  interest $      578 

For  33  days,  this  is  interest  on  $48,045  at  the  rate 

per  annum  of 13%  plus 


CHAPTER  XII 

BORROWING  BY  MEANS  OF  EXCHANGE 

§  83.  The  "dollar"  loan  by  a  foreign  bank  in  New  York. — 
As  already  intimated,  we  do  not,  in  addressing  ourselves 
to  borrowing  by  means  of  foreign  exchange,  have  refer- 
ence to  the  ordinary  and  more  familiar  types  of  borrowing 
across  national  boundary  lines,  but  to  a  certain  special  and 
technical  operation  with  a  long  foreign  bill  whereby  a  local 
banker  manages  to  obtain  the  use  of  a  fund  at  home  for 
the  term  of  the  bill.  The  instrument  in  question,  the 
so-called  "finance  bill,"  is  drawn  by  a  banker  upon  a 
banker,  and  is  somewhat  sharply  distinguished  from  the 
long  bill  arising  out  of  an  export  of  goods  and  drawn  by 
a  merchant  (whether  upon  a  foreign  merchant  or  a  foreign 
bank).  We  speak  of  borrowing  by  means  of  exchange  for 
the  reason  that  (treating  countries  as  units)  the  borrow- 
ing country  sells  the  lending  country  no  securities,  such 
as  bonds  or  stocks  or  notes,  but  merely  deals  in  exchange 
upon  it.  In  these  operations  bonds  or  stocks  are  usually 
deposited  as  collateral  with  the  foreign  accepting  bankers 
(or  their  local  agents),  but  such  deposits  are  in  no  sense 
sales. 

Borrowing  by  means  of  exchange  is  not  a  procedure  which 
must  by  its  very  nature  be  confined  to  foreign  exchange 
While  details  vary,  it  comes  fundamentally  to  borrowing 
by  means  of  an  acceptance  which  is  granted  to  your  long 
bill  by  some  one  else  (not  acting  in  the  capacity  of  your 
debtor)  for  the  purpose  of  enabling  yon  to  sell  the  instru- 
ment for  local  funds.  You  do  not  borrow  from,  but  merely 
by  the  aid  of,  this  one  who  does  the  accepting.     The  accept  - 

359 


300  FOREIGN  EXCHANGE 

ance  in  this  crse  is  of  the  kind  known  at  law  as  an  "accom- 
modation acceptance."  There  is  nothing  in  the  nature  of 
the  whole  operation  precluding  resort  to  it  within  purely 
domestic  limits  so  that  it  would  involve  and  produce  purely 
domestic  exchange.  But,  in  fact,  it  has  little  development 
in  connection  with  domestic  exchange,  none  within  the 
United  States,  and  is  of  consequence  only  in  the  field  of 
foreign  exchange. 

Let  us  first  consider  a  so-called  "dollar"  loan  made  or 
placed  in  New  York  by  a  foreign  bank.  Described  in  more 
general  terms,  this  is  a  loan  by  a  banker  of  country  A  made 
in  country  B  in  terms  of  the  local  currency  of  country 
B.1  The  cause  for  any  general  placing  of  such  loans  will 
be  the  existence  of  higher  discount  or  interest  rates  in  coun- 
try B  than  in  country  A.  Throughout  the  discussion  we 
shall  choose  dealings  between  London  and  New  York  as 
illustrations. 

Assume  the  following  data : 

Money  can  be  loaned  in  New  York  for  quarter-year 

periods  on  excellent  security  at 5% 

Discount  rate  in  London  for  bankers'  90  days  ac- 
ceptances        &A% 

Rate  for  sight  sterling  in  New  York 4.87 

Rate  for  90  days'  sight  sterling  in  New  York 4.8240 

An  English  bank  has  an  agent  on  our  side  of  the  water 
which  knows  of  an  institution  in  New  York  that  is  ready 
to  pay  5%  per  annum  for  a  loan  of  from  forty-five  to  fifty 
thousand  dollars  for  a  period  of  90  days  or  thereabouts. 

i  We  speak  of  the  foreign  bank  initially  interested  in  the  opera- 
tion as  "making"  the  loan.  In  the  case  before  us  it  does  in  a  sense 
make  the  loan,  but  it  does  not,  nevertheless,  bear  the  burden  of 
the  cash  advance.  To  bear  this  burden  would  mean  to  be  out  present 
money  (cash  or  money  funds)  in  return  for  future  money.  But 
this  bank  is  not,  in  consequence  of  the  operation  as  an  entirety,  out 
any  present  money.     See  the  text. 


BORROWING  BY  MEANS  OF  EXCHANGE    361 

An  opportunity  for  profit  being  perceived,  the  agent  is 
instructed  to  draw  upon  the  English  bank,  its  principal, 
a  bill  for  £10,000  at  90  days'  sight,  to  sell  the  bill  forth- 
with in  New  York  for  dollars,  and  to  place  these  dollars  as 
a  loan  for  93  days  with  the  New  York  house  in  question. 
Assume  that  this  is  done  on  the  first  of  March.  The  bill, 
being  sold  at  4.8240,  yields  $48,240.  This  sum,  loaned  out 
at  5%  for  93  days  (the  term  of  the  bill  including  the  days 
of  grace),  earns  $623  of  interest,  and  on  June  2d  a  total 
repayment  of  $48,863  will  be  made  to  the  agent.  It  be- 
comes the  latter 's  immediate  duty  to  expend  this  for  sight 
sterling  and  remit  the  same  to  the  London  principal  to  be 
used  to  pay  off  the  bill  for  £10,000  which  was  originally 
drawn.  This  instrument,  having  been  accepted  in  due 
course  on  March  8th,  became  payable  on  June  9th,  and  the 
sight  sterling  started  from  New  York  on  June  2d  or  3d 
will  have  time  to  reach  London  by  the  9th.  Without  any 
specially  untoward  calendar  of  steamer  sailings,  the  loan 
on  this  side  can  be  made  for  the  full  number  of  days  of 
life  of  the  acceptance  on  the  other  side,  in  this  instance  93 
days. 

Clearly  the  outcome  to  the  English  banker,  who  has  engi- 
neered this  operation,  depends  upon  the  position  of  the 
New  York  rate  for  sight  sterling  on  June  2d.  If  we  assume 
that  at  the  end  of  the  loan  this  rate  stands  at  4.87,  where 
it  was  in  the  beginning,  we  may  make  up  the  following 
account : 

OUTCOME  OF  THE  OPERATION  TO  THE  LONDON 
ACCEPTING  BANK 

March  1  Amount  of  the  90  days'  draft  on  this  hank  sold 

in  New  York £10,000 

March  1  Dollars  received  from  the  same  and 

loaned  out $48,240 

June  2     Dollars  returned  from  loan  including 

interest    $48,863 


3G2  FOREIGN  EXCHANGE 

Juno  2     Amount  of  sight   sterling  purchased  with  lat- 
ter, at  4.87 £10,033 


Profit  £       33 

The  effect  of  a  deviation  of  the  sight  rate  from  4.87  at 
the  end  of  the  loan  period  is  illustrated  by  the  figures 
beneath. 


Rate  for 

Amount  of 

Profit  of 

Sight  Sterling 

sterling  purchased 

the  London 

on  June  2 

with  $48,863 

accepting  bank 

4.88 

£10,013 

£13 

4.86 

£10,054 

£54 

4.84 

£10,095 

£95 

The  London  accepting  bank  has  acted  as  principal  and 
risk-taker  in  this  enterprise,  and  the  gain,  if  any,  goes  to 
it.  This  gain  is  not  interest,  for  the  reason  that  the  said 
bank  does  not,  as  a  result  of  the  operation  as  an  entirety, 
make  any  advance  of  its  own  funds.  It  is  not  commission, 
for  the  reason  that  it  is  not  a  stipulated  fee  received  from 
some  outside  person  or  establishment  for  a  service  rendered. 
It  is  profit.  And  as  profit,  the  primary  variable  upon 
wrhich  it  depends  is  the  New  York  rate  for  sight  sterling 
on  the  day  of  maturity  of  the  loan.  On  this  day  the  London 
bank  comes  into  the  ownership  of  a  contractually  prede- 
termined number  of  dollars  in  New  York,  namely,  $48,863. 
Its  scheme  is  to  convert  these  into  sight  sterling  bills  which, 
when  received  in  London,  will  serve  to  discharge  its  accept- 
ance for  £10,000.  Any  profit  which  it  may  glean  will  con- 
sist in  an  excess  of  the  sterling  so  purchased  over  the 
£10,000  required.  Clearly,  the  lower  rate  or  price  for 
sight  sterling  in  New  York  on  the  critical  day,  the  greater 
the  number  of  pounds  of  it  that  can  be  bought  with  the 
fixed  sum  of  dollars,  and  the  larger  the  surplus  or  profit. 
In  this  case,  then,  though  the  burden  of  the  advance  is  not, 


BORROWING  BY  MEANS  OF  EXCHANGE    363 

the  risk  of  the  exchange  is  shouldered  by  the  accepting  bank. 
This  institution  may  hedge  at  the  time  of  placing  the  loan, 
if  it  chooses  so  to  do,  by  making  a  contract  to  buy  sight 
sterling  in  New  York  for  future  delivery  (see  §  91  below). 

The  New  York  bank  or  trust  company  which  has  served 
in  the  capacity  of  agent  puts  out  no  funds  of  its  own 
and  takes  no  risks.  Whatever  compensation  it  receives  for 
making  the  immediate  arrangements  and  taking  charge  of 
the  collateral  put  up  by  the  borrower,  will  be  in  the  nature 
of  a  commission  paid  by  its  principal  in  London  and  charge- 
able by  the  latter  against  the  profits  which  the  venture  has 
afforded. 

The  New  York  borrower  has  received  a  loan  of  some 
forty-eight  thousand  dollars  for  93  daj^s.  Although  these 
dollars  undeniably  came  in  the  first  instance  from  the  com- 
pany we  have  called  the  agent,  neither  this  company,  nor 
its  principal  in  London,  is  the  true  lender.  The  true  lender 
must  be  that  party  who  holds  the  long  sterling  bill  during 
the  length  of  its  life,  who  invests  in  it.  The  normal  history 
of  the  bill  would  be  this:  the  banker  who  buys  it  in  New 
York  forwards  it  immediately  to  his  London  correspondent 
for  discount  and  cash  credit,  and  forthwith  recovers  what 
he  has  laid  out  in  it,  either  by  the  sale  of  sight  sterling 
against  it,  or  by  the  refraining  from  the  purchase  of  sight 
sterling  which  he  would  otherwise  have  had  to  buy.  He 
makes  no  advance  for  a  deferred  return.  Some  money 
dealer  in  the  London  market,  unidentified  so  far  as  our 
illustration  goes,  comes  forward  to  discount  the  instru- 
ment after  it  has  been  accepted  by  the  drawee  bank.  This 
money  dealer  is  the  real  or  ultimate  lender.  The  borrower 
in  New  York  has  a  loan,  while  this  party  in  London  does 
the  corresponding  waiting,2 

2  The  dollars  received  by  the  borrower  from  the  agent  of  the 
London  accepting  bank  are  no  doubt  the  property  of  the  latter. 
This  leads  U8  naturally  to  speak  of  the  accepting  bank   us  "making" 


364  FOKKKiX   KXCHANGK 

It  is  true  this  history  might  vary  in  some  particulars. 
The  banker  who  first  buys  the  long  sterling  bill  in  New 
York,  could  refrain  from  discounting  it  in  London  and 
could  hold  it  as  an  investment,  in  which  case  he  would 
become  the  ultimate  lender.  But  this  would  hardly  be 
normal,  because  a  banker  on  our  side  would  not  be  likely 
to  invest  in  exchange  at  a  time  when  our  local  money 
rates  are  higher  than  the  London  discount  rates,  namely, 
at  a  time  when  our  borrowing  by  means  of  exchange  is 
appropriate.  Another  and  more  natural  variation  would 
be  for  the  New  York  agent  which  draws  the  long  bill  to 
forward  it  to  London  instead  of  selling  it  for  cash  on  this 
side.  This  agent  may  have  other  correspondents  in  London 
than  the  bank  upon  which  it  has  drawn.  It  may  send 
the  bill  to  one  of  these  for  discount  and  itself  sell  sight 
sterling  against  it,  and  in  this  manner  procure  the  dollars 
to  lend  out  in  New  York.3 

the  loan.  It  certainly  appears  as  lender  if  we  take  into  view  only 
what  happens  in  this  country.  But  the  very  dollars  loaned  came 
from  the  sale  of  a  bill  which  the  London  acceptor  does  not  pay 
until  the  repayment  of  the  loan  on  this  side  of  the  water  has  taken 
place  and  has  provided  it  with  the  necessary  funds.  In  other 
words,  as  a  result  of  the  operation  viewed  in  its  entirety,  the  accept- 
ing bank  makes  no  advance  of  cash  or  of  its  own  funds.  If  it 
lends  dollars  in  New  York,  it  is  itself  the  recipient  of  a  virtual  loan 
of  dollars  through  the  offices  of  the  party  in  London  that  discounts 
the  long  bill  for  the  one  who  bought  it  and  paid  dollars  for  it  in 
New  York. 

Should  the  London  bank,  still  acting  as  principal,  and  still 
conceiving  and  engineering  the  operation,  desire  to  take  the  burden 
of  the  advance  as  well  as  the  risk  of  exchange,  it  might  do  so  by 
changing  its  procedure.  It  might,  for  instance,  say  to  its  agent  in 
Xew  York,  "Sell  £10,000  of  sight  drafts  on  us,  and  lend  the  dollars 
which  they  fetch,  $48,500  say,  in  your  money  market  for  three 
months.  When  you  receive  these  dollars  back  with  interest,  convert 
the  whole  into  sight  sterling  and  forward  it  to  us." 

s  There  is  no  purely  legal  reason  why  the  long  bill  should  not  be 
sent  to  the  very  London  bank  upon  which  it  is  drawn  to  be  offered 


BORROWING  BY  MEANS  OF  EXCHANGE    365 

§  84.  The  "sterling"  (franc  or  mark)  loan. — The  sterling 
loan  bears  its  name  because  the  borrower  receives  a  stipu- 
lated amount  of  long  sterling  (or  the  proceeds  in  local 
money  from  the  sale  of  this)  and  agrees  to  make  a  repay- 
ment in  the  same  amount  of  sight  sterling.  The  period 
of  the  loan  is  the  length  of  the  life  of  the  long  sterling 
bill  drawn  to  effect  it.  The  object  and  effect  of  the  ar- 
rangement, as  contrasted  with  the  dollar  loan,  is  to  throw 
the  risk  of  exchange  upon  the  borrower.  To  illustrate : 
The  New  York  agent  of  the  London  accepting  bank  draws 
upon  the  latter  a  90  days'  bill  for  £10,000,  and  delivers  this 
instrument,  or  the  forty-eight  odd  thousand  dollars  it  will 
fetch  on  the  market,  over  to  the  New  York  borrower  against 
a  deposit  of  collateral.  The  latter  agrees  to  make  a  repay- 
ment of  £10,000,  plus  a  commission  of  say  %  of  1%,  in 
bankers'  demand  sterling  bills  (or  in  dollars  enough  to 
buy  them,  this  being  a  mere  matter  of  detail).  The 
£10,000  is  the  amount  or  face  value  of  the  long  sterling 
turned  over  to  the  borrower.  Upon  the  fact  that  it  is 
repayable  in  sight  sterling  hangs  the  whole  story.  The 
commission  of  %  of  1%,  or  whatever  per  cent,  it  may  be,  is 
the  fee  of  the  London  bank  for  granting  its  acceptance. 
The  borrowing  bank  makes  no  payment  of  a  stipulated  or 
contract  amount  of  interest  to  any  party.  Nevertheless,  for 
a  reason  that  will  soon  appear,  the  loan  will  cost  it  interest. 

Taking  the  same  data  with  respect  to  rates  for  money 
and  exchange  as  in  the  last  preceding  section,  we  now 
assume  that  the  borrowing  bank  proceeds  to  sell  the  90 
days'  bill  which  has  been  delivered  to  it.  It  sells  at  4.8240 
and  receives  $48,240  for  immediate  employment  at  home. 
Niriety-three  days  later  the  bank  will  be  obliged  to  return 
£10,000,  plus  %  of  1%,  or  £37.5,  or  a  total  of  £10,037.5, 
in  bankers'  sight  bills  on   London.     If  the  rate   \'<>r  such 

on  the  money  market  by  this  bank  itself.     Bui   bo  far  as  the  writer 
knows,  banks  never  like  to  offer  their  own  acceptance  for  sale. 


366  FOREIGN  EXCHANGE 

bills  stands  at  4.87  (which  accords  with  the  first  assump- 
tion made  in  the  preceding  section)  this  sterling  will  cost 
it  $48,882.63.  The  following  then  will  be  an  account  of 
the  operation : 

INTEREST  COST  OF  THE  LOAN  TO  THE  BORROWER 

Dollars  received  by  borrower  at  the  beginning $48,240.00 

Dollars  required  to  discharge  obligation  at  maturity. .     48,882.63 

Difference,  or  93  days'  interest  cost  on  $48,240 $      642.63 

Rate  of  this  interest  cost  per  annum 5.23% 

SAME  WITH  SIGHT  RATE  AT  4.84 4 

Dollars  received  by  borrower  in  the  beginning $48,240.00 

Dollars  required  to  discharge  obligation  at  maturity. .     48,581.50 
(£10,037.5  X  4.84  =  $48,581.50) 

Difference,  or  93  days'  interest  cost  on  $48,240 $      341.50 

Rate  of  same  per  annum 2.78% 

This  example  shows  that  if  the  sight  rate  were  at  4.87 
at  the  beginning  of  the  loan  period  (and  the  rate  for  90 
days'  sterling  at  the  correspondingly  high  point  of  4.8240) 
and  that  if  the  sight  rate  had  fallen  to  4.84  at  the  expiry 
of  this  period,  the  loan  would  cost  the  borrower  only  2%%. 
As  a  case  favorable  to  the  borrower,  this  is  a  very  strong 
one,  but  it  serves  to  make  clear  the  importance  of  the  risk 
of  exchange  in  connection  with  the  interest  cost  of  a  sterling 
loan.  After  having  obtained  the  loan,  the  borrower  is  in 
effect  short  of  sight  sterling — that  is,  under  a  commitment 
to  buy  a  sum  of  this  exchange  at  a  future  date.  It  is 
possible  to  hedge  by  buying  sight  sterling  for  future  de- 
livery (see  §  91).  But  if  the  borrowing  house  does  not 
hedge  against  this  risk,  the  rule  is,  the  cheaper  sight 
sterling  at  the  maturity  of  the  loan  the  better  for  it.     The 

♦  At  time  of  expiration  of  the  loan. 


BORROWING  BY  MEANS  OF  EXCHANGE    367 

rule  is  also  that  the  higher  sight  sterling,  and  consequently 
also  long  sterling,  at  the  time  it  contracts  the  loan,  the 
better  for  it,  because  the  greater  the  number  of  dollars  it 
will  receive  at  the  beginning  against  a  commitment  to  de- 
liver a  stated  amount  of  sterling  at  the  end. 

In  the  case  of  the  sterling  loan,  as  in  the  case  of  the 
"dollar"  loan,  the  real  lender  is  the  institution  in  the  Lon- 
don money  market  which  discounts  and  carries  the  long 
sterling  bill  from  acceptance  till  maturity.  The  explana- 
tions given  before  apply  here  as  well. 

In  the  case  of  the  sterling  loan,  the  accepting  bank  in 
London  makes  a  commission  merely.  It  takes  no  risk  of 
exchange  and  makes  no  profit.  There  is  due  it  £37.5  for 
the  service  rendered  by  accepting.  This  is  compensation 
for  that  other  kind  of  risk  than  a  risk  of  exchange,  which 
it  takes  in  assuming  liability  to  pay  the  bill  before  being 
provided  with  cash  to  make  the  payment.  It  is  true  it 
has  the  promise  of  the  American  borrower.  Also,  the  risk 
is  reduced  by  reason  of  the  deposit  of  collateral. 

In  the  past,  French  and  German  banks  have  sometimes 
made  loans  in  New  York  under  the  same  general  plan  as 
that  followed  by  the  London  banks.  They  may  make 
"dollar"  loans,  or  they  may  make  "franc"  or  "mark" 
loans,  the  latter  corresponding  in  nature  and  effect  to 
"sterling"  loans. 

§85.  The  borrowing  bank's  sale  of  its  own  long  bill. — 
Continuing  with  the  subject  of  long  exchange  as  a  means 
of  procuring  a  virtual  loan  from  the  foreign  money  mar- 
ket, the  bill  in  the  case,  as  heretofore  encountered,  has 
been  one  drawn  by  the  local  agenl  of  flic  London  accepting 
bank.  The  borrowing  bank's  sale  of  its  own  long  draft 
gives  rise  simply  to  a  variant  form  of  the  sterling  loan. 

If,  for  example,  a  New  York  bank  or  exchange  house: 
having  an  acceptance  account  with  a  bank  in  London  (corn- 
pare  pages  144-7)  and  therefore  having  the  power  to  dra^ 


308  FOREIGN  EXCHANGE 

long:  sterling,  sells  its  90  days'  bill  for  dollars  to-day  and 
expends  dollars  some  93  days  hereafter  to  buy  sight  ster- 
ling for  cover,  it  obviously  has  a  virtual  loan.  It  has,  as 
the  saying  goes,  93  days'  ''use"  of  the  dollars  first  procured. 
Its  motive,  it  is  true,  may  be  primarily  to  speculate  for  a 
fall  in  the  rate  for  demand  sterling  rather  than  to  procure 
the  use  of  funds,  but  whatever  be  the  motive,  it  does  have 
the  use  of  the  funds. 

The  explanations  regarding  risk  of  exchange,  and  the 
possibility  of  hedging,  applicable  to  the  sterling  loan  placed 
through  an  agent,  and  already  given,  are  also  applicable 
here.  They  need  not  be  repeated  in  extended  order.  But 
to  avoid  being  too  concise  in  handling  these  technical  sub- 
jects, it  will  be  well  to  give  one  illustration  involving  a 
draft  by  the  borrowing  bank  itself. 

CALENDAR  AND  ACCOUNT  OF  THE  OPERATION 

June  1  90  days'  draft  for  £10,000  drawn  and  sold  by  New  York 
bank 

Sight  sterling  rate  in  New  York 4.85 

London  discount  rate  for  this  bill ....   31/6% 
90  days'  sterling  rate  in  New  York. .  .   4.8040 
The  draft  is  sold  by  the  drawer  to  a  new  York 

buyer  for   $48,040 

The  buyer  forwards  it  to  his  correspondent  in 
London  for  discount  in  the  London  market 
and  cash  credit. 
June  8  The  draft  arrives  in  London  and  is  accepted  by 
the  drawee  bank.  This  sets  the  maturity  date 
on  Sept.  9th  (93  days  later). 
Sept.  2  Day  to  buy  in  sight  sterling  as  cover. 

The  New  York  drawing  bank  is  obligated  to 
put  the  London  drawee  bank  in  funds  to  en- 
able it  to  discharge  the  acceptance  on 
Sept.  9th.  Its  deposit  with  the  latter  might 
be  so  large  on  this  date  that  a  special  re- 


BORROWING  BY  MEANS  OF  EXCHANGE    369 

mittance  of  sight  bills  as  cover  would  be 
unnecessary ;  that  is,  the  London  bank  might 
be  able  to  reimburse  itself  from  this  bal- 
ance without  the  balance  being  specially 
fortified  to  stand  such  a  drain,  but  this  is 
unlikely,  and  in  any  case  we  have  to  assume 
the  special  remittance  of  cover,  to  find  the 
outcome  and  interest  cost  of  the  opei'ation. 
This  cover  must  be  bought  and  mailed  in 
time  to  reach  London  on  Sept.  9th. 

Sight  sterling  in  New  York  still  at  4.85 

Total  cover  required 

To  discharge  acceptance £10,000 

To   pay    commission    for   ac- 
ceptance     37.5 

(At  assumed  rate  of  %  of  1%) 


£10,037.5 
Cost  of  cover  at  4.85  (10,037.5  X  4.85) . . .  $48,681.87 

SUMMARY 

Dollars  received  by  borrowing  bank  on  June  1 $48,040.00 

Dollars  paid  out  to  discharge  obligation,  Sept.  2 48,681.87 

Difference,  or  interest  cost  for  93  days 641.87 

Rate  of  this  interest  per  annum  (on  $48,040) . 5.24%  5 

§  86.  The  spread  between  the  local  and  the  foreign  money 
rates. — The  interest  cost  of  the  loan  just  discussed  (or  vir- 
tual loan,  speaking  more  precisely)  turns  out  to  be  514%, 
when  the  London  discount  rate  is  but  3^%.  The  rate  of  ex- 
change stood  at  the  same  figure  at  the  end  as  at  the  be- 
ginning of  the  operation,  and  therefore  neither  advantage 
nor  disadvantage  has  come  out  of  the  risk  of  exchange. 
What  is  the  cause  then  of  the  interest  cost's  being  so  much 
in  excess  of  the  foreign  money  rate?     The  main  cause  is 

■''Computed  on  the  liasis  of  .'i<i.">  days  to  1 1 1 « -  year. 


370  FOREIGN  EXCHANGE 

the  acceptance  commission  which  the  New  York  borrowing 
bank  must  pay.  A  minor  cause  is  the  English  stamp  tax. 
Then  again,  the  full  theoretical  worth  of  the  90  days'  ster- 
ling sold  by  our  bank  on  June  1st  was  $4.80435  per  pound, 
whereas  we  supposed  the  sale  to  take  place  at  the  next 
even  rate  below,  namely  4.8040,  which  gives  a  slight  profit 
to  the  New  York  buyer  of  this  exchange.  All  taken  to- 
gether, the  interest  cost  is  1%%  above  the  London  discount 
rate.6  Of  this,  Vkjo  is  due  to  the  acceptance  commission. 
To  explain :  the  acceptance  commission  assumed  in  our 
illustrations  is  Vs  of  1%  per  month  of  life  of  the  accepted 
bill,  or  %  of  1%  for  what  was  (roughly)  a  three  months' 
bill.  These  commissions  vary,  but  this  is  a  common  figure. 
(As  to  the  reason  why  the  amount  of  commission  increases 
with  the  term  of  the  bill,  see  §  50,  page  181.)  A  charge 
of  *6  of  1%  per  month  is  one  running  at  the  rate  of  1%% 
per  annum.  Thus  a  sterling  loan  will  cost  the  New  York 
borrower  V/2%  per  annum  above  the  London  discount  rate, 
because  of  the  acceptance  commission  alone.7  Therefore, 
it  is  evident  that  the  sterling  loan  does  not  pay  an  operator 
on  our  side  of  the  water  unless  one  of  two  things  make  it 
pay,  namely,  either  (1)  a  somewhat  greater  excess  of  the 
New  York  over  the  London  money  rate  than  VA%,  or  (2) 

e  A  small  part  of  this  excess  is  also  due  to  the  fact  that  the 
London  money  rate  is  a  discount  rate,  while  what  we  are  here  com- 
puting is  an  interest  rate. 

»  If  the  borrower  uses  a  quarter-year  bill,  the  period  of  his  loan 
is  a  quarter  of  a  year.  The  commission  will  be  %  of  1%.  This 
is,  precisely  speaking,  %  of  1%  of  the  face  value  of  the  sterling 
bill,  but  since  the  rate  of  exchange  between  dollars  and  pounds 
ordinarily  fluctuates  within  a  small  compass,  it  will  necessarily 
at  the  end  of  the  loan  require  an  expenditure  to  pay  it,  amounting 
very  close  to  %  of  1%  of  the  dollars  originally  borrowed.  What- 
ever percentage  the  extra  dollars  (required  at  the  end  to  buy  the 
extra  sterling  to  pay  the  commission)  bear  to  the  dollars  originally 
secured,  this  percentage  is  interest  cost.  An  interest  cost  of  %  of 
1%  per  quarter  is  one  at  the  rate  of  \V-i%  per  year. 


BORROWING  BY  MEANS  OF  EXCHANGE    371 

an  attractive  speculation  on  the  future  course  of  sight  ster- 
ling in  New  York.  The  illustration  on  page  366  shows 
a  case  where  a  very  fortunate  speculation  on  this  rate 
reduced  the  interest  cost  of  a  sterling  loan  to  2%%  per 
annum ! 

It  appears  then  by  way  of  summary  that  a  London 
bank  will  grant  its  acceptance  to  a  bill  drawn  and  sold 
in  New  York  for  the  purpose  of  putting  some  New  York 
house  in  funds  for  a  period  equal  to  the  term  of  the  bill. 
Sometimes  the  instrument  is  drawn  by  a  mere  agent  of  the 
London  bank,  sometimes  by  the  New  York  borrowing  house 
itself.  The  London  accepting  bank  does  not  make  the  ad- 
vance of  actual  funds  or  cash  which  enables  the  American 
borrower  to  enjoy  a  loan.  As  the  saying  goes,  it  merely 
lends  its  credit.  It  does  this  by  becoming  unconditionally 
bound  to  pay  the  long  bill  in  the  case,  that  is,  by  accepting 
this  bill.  It  is  this  giving  of  the  strength  of  its  name  to 
the  instrument  that  enables  it  to  be  sold  so  readily  and 
at  such  a  favorable  rate  in  the  London  money  market. 
It  makes  a  profit  in  the  case  of  the  dollar  loan  where  it 
takes  the  risk  of  exchange,  and  a  commission  in  the  case 
of  the  sterling  loan  where  the  borrower  takes  the  risk  of 
exchange.  The  actual  advance  of  cash  or  funds  which 
makes  possible  the  enjoyment  of  the  virtual  loan  by  the 
New  York  house,  is  made  by  the  party  in  London  that 
discounts  the  acceptance  there.  It  is  the  action  of  this 
party  which  makes  it  possible  for  any  exchange  bank  in 
New  York  to  pay  dollars  for  the  long  bill  on  the  day  of 
its  creation  without  itself  making  an  advance  of  present 
money  for  a  deferred  return,  for  it  is  this  which  enables 
the  said  exchange  bank  to  recover  its  dollars  immediately 
by  the  sale  of  sight  sterling. 

When  the  English  banker,  proposing  to  accept  one  of 
these  loan  bills  drawn  by  his  own  agent,  shows  his  prefer- 
ence as  between  the  dollar  loan  and  the  sterling  loan,  we 


372  FOREIGN  EXCHANGE 

can  infer  his  opinion  with  respect  to  the  probable  future 
course  of  siprht  sterling  in  New  York.  A  preference  for 
the  dollar  loan  is  a  clear  indication  that  he  anticipates  low 
Bight  sterling  at  the  end  of  the  loan  period.  For  if  he 
places  a  dollar  loan,  this  is  the  position  of  the  sight  rate 
that  would  benefit  him  most.  The  cheaper  demand  bills 
on  London  may  be  at  the  end,  the  more  of  them  will  be 
procurable  for  the  fixed  number  of  dollars  to  be  received 
back,  and  consequently  the  larger  the  excess  of  this  sterling 
over  the  amount  required  to  discharge  the  maturing  accept- 
ance. A  reluctance  to  make  dollar  loans,  or  what  is  the 
same  thing,  a  preference  for  sterling  loans,  shows  naturally 
a  belief  in  the  contrary  future  for  sight  sterling  in  New 
York. 

The  interests  of  the  New  York  borrower,  with  respect 
to  the  choice  between  dollar  and  sterling  loan,  run  exactly 
counter  to  those  of  the  English  acceptor.  If  demand  ster- 
ling turns  out  cheap  at  the  end  of  the  loan  period  it  will 
be  best  for  him  if  he  has  agreed  to  a  sterling  rather  than 
a  dollar  loan,  and  vice  versa. 

§  87.  A  joint-account  transfer  of  loanable  funds. — In  the 
case  of  most  operations  in  exchange  involving  activity  on 
the  part  of  a  given  bank  and  its  foreign  correspondent,  one 
institution  assumes  the  risks  (such  as  they  may  be)  and 
takes  any  gains,  while  the  other  acts  as  a  mere  depository 
or  agent,  or  grants  an  acceptance  for  a  commission.  But 
it  is  possible  for  the  two  banks  to  establish,  for  the  pur- 
poses of  any  transaction,  what  is  known  as  a  "joint- 
account."  A  joint-account  operation  in  foreign  exchange 
may  be  defined  as  one  which  is  effected  through  the  coopera- 
tion of  two  banks  or  exchange  houses  in  different  countries 
under  an  agreement  to  share  in  common  the  risks  and 
the  gains  involved.  It  would  appear  that  these  are  usually 
divided  half  and  half,  rather  than  in  any  other  propor- 
tion. 


BORROWING  BY  MEANS  OF  EXCHANGE    373 

Joint-accounts  are  more  particularly  appropriate  in  con- 
nection with  borrowing  by  means  of  exchange  and  arbitrage 
of  exchange.  When,  for  instance,  money  rates  are  higher 
in  New  York  than  in  London,  two  banks,  one  in  each  of 
the  cities,  may  form  a  joint-account  to  pump  loanable  funds, 
as  we  may  express  it,  from  the  one  place  to  the  other. 
The  two  cooperators  take  action  to  make  something  for 
themselves  out  of  an  opportunity  which  the  conditions 
present.  One  draws  and  the  other  accepts.  From  the 
language  sometimes  employed  in  the  prints  of  London,  one 
would  gather  the  idea  that  the  two  were  conspirators. 
They  do  conspire,  or  at  least  make  common  cause,  but  it 
is  difficult  to  see  what  is  reprehensible  in  their  acts,  for 
these  amount  simply  to  a  form  of  trading,  fundamentally 
a  form  of  arbitraging  or  equalizing,  to  which,  under  analy- 
sis, practically  all  trading  reduces  itself. 

The  illustration  to  be  given  beneath  shows  not  only  a 
joint-account  (which  of  itself  is  so  simple  as  hardly  to  jus- 
tify an  independent  example),  but  also  shows  a  new  use  for 
the  banker's  long  bill,  that  is,  a  use  different  from  any  here- 
tofore considered  in  this  book.  Suppose  that  on  a  given 
day,  as  July  1st,  the  Bank  of  A  of  New  York  has  the  follow- 
ing facts  before  it : 

Sight  sterling  in  New  York  at 4.8745 

London  arrival  discount  rate  for  bankers'  90  days' 

bills    3% 

Consequently  90  days'  bankers'  bills  in  New  York  at.  .   4.8350 
The  American  XL  Company's  one-year  5%  gold  notes 
now  having  just  6  months  to  run  can  be  bought 
in  a  large  amount  at  99.51,  which  is  on  a  6%  basis. 

The  bank  now  falls  to  reasoning  in  this  manner:  "Sight 
sterling  is  high.  London  discounts  are  low  compared  with 
rates  in  our  money  market.  We  can  sell  a  90  days'  sterling 
bill   at   a   very   good   figure   indeed   to-day.      (This    figure 


374  FOR  El  ON  EXCHANGE 

is  high  for  the  double  reason  that  the  sight  rate,  from 
which  it  is  derived,  is  high,  and  the  spread  from  the  sight 
rate  down  to  the  90  days'  rate  is  a  narrow  one  because  the 
London  discount  rate  is  low.]  We  can  buy  the  notes  of 
the  XL  Company,  which  we  regard  as  a  high  class  invest- 
ment, at  a  price  to  yield  us  6%  if  we  hold  them  till  their 
maturity  6  months  hence.  These  notes  are  a  desirable  pur- 
chase on  this  basis,  but  since  we  believe  that  in  three  months 
or  so  they  will  sell  on  a  lower  basis,  as  about  5%,  they 
become  still  more  attractive,  in  our  view,  as  a  present  pur- 
chase. If  our  anticipation  proves  correct,  we  could  sell 
them  out  at  the  end  of  the  three  months  at  such  a  price 
as  to  yield  us  better  than  6%  for  the  time  we  carried  them. 
It  would  seem  good  to  arrange  with  our  correspondent,  the 
Bank  of  B  of  London,  to  carry  on  joint-account  about  a 
half  million  of  these  notes  by  means  of  our  90  days'  sterling 
bill.  The  chances  for  profit  are  enhanced  by  the  prob- 
ability that  sight  sterling  will  not  be  above  4.85  three 
months  hence. 

Assume  that  by  an  exchange  of  cables  the  joint-account 
is  established  on  July  1st,  and  the  initial  steps  in  the 
enterprise  are  taken.  Assume  further  that  when  the  day 
arrives  for  buying  in  the  cover,  the  predictions  of  the 
Bank  of  A  are  fulfilled,  so  that  the  notes  are  selling  on 
a  5%  basis,  and  sight  exchange  can  be  bought  for  4.85. 
The  following  results: 

CALENDAR  OF  THE  OPERATION 

Price  of  the  notes 

July  1st  The  notes,  which  bear  interest  at  5%,  payable 

semi-annually,    have    just    6   months   to   run. 

They  will  pay   102.50   at   maturity,   100   for 

principal   and  2.50   last   interest   installment. 

They  are  selling  to-day  at $  99.51 

or  on  a  6%  basis. 


BORROWING  BY  MEANS  OF  EXCHANGE    375 

Oct.  2d  On  this  date  these  notes  can  be  sold  on  a  5% 
basis,  or  for  a  price  which  as  figured  by  prac- 
tical dealers  will  come  to  this :  8 

"Flat"  price   100.00 

Accrued   interest    1.26         101.26 

Transactions  of  Bank  of  A 

July  1st  Buys  $500,000   par   of   notes   at   99.51   at 

cost  of   $497,550.00 

Sells  £102,906  of  90  days'  bills  at  4.8350  for     497,550.50 
Oct.  2d    Sells  $500,000  par  of  notes  at  101.26  for.  . .     506,300.00 

Buys  £102,906  sight  bills  at  4.85  at  cost  of. .     499,094.10 

SUMMARY 

Receipts 
July  1st  From  sale  of  long  sterling.   $497,550.50 
Oct.  2d    From  sale  of  notes 506,300.00     $1,003,850.50 

Expenditures 

July  1st  For  the  notes $497,550.00 

Oct.  2d    For  sterling  cover   499,094.10 

Balance   PROFIT    7,206.40     $1,003,850.50 

The  operation  as  an  entirety  yields  a  profit  of  $7206.40, 
which  is,  owing  to  the  agreement  for  a  joint-account,  di- 
visible between  the  two  banks.  We  speak  advisedly  of  this 
gain  as  profit.  It  is  true,  had  the  Bank  of  A  invested  its 
own  funds  in  the  notes,  the  account  would  have  to  be  made 
up  as  follows : 

July  1  Outlay,  amount  paid  for  notes $497,550 

Oct.    2  Return,  received  from  sale  of  same 506,300 


Difference,  or  interest  on  investment  for  93  days.  . .         8,750 
This  is  interest  on  $497,550  at   rate  <>f 6.9%  per  annum 

*  This  everyday  method  of  adding  accrued  nominal  interest  to 
flat  prices  gives  an  incorrect  result.  Usually  the  error  is  very 
small. 


376  FOREIGN  EXCHANGE 

Tin-  gain  received  from  their  sale  at  the  advanced  price 
(which  they  attained  as  they  approached  maturity)  would 
be  interest  on  the  amount  invested.  But  in  the  operation 
taken  as  an  entirety  neither  the  Bank  of  A  on  this  side, 
nor  the  Bank  of  B  on  the  other  side,  made  the  slightest 
advance  of  actual  cash.  What  they  did  was  to  combine 
their  forces  in  an  exchange  operation  whereby  the}'  vir- 
tually borrowed  money  at  the  low  London  discount  rate  and 
employed  it  in  New  York  at  the  higher  rate  there  prevail- 
ing. They  took  the  risk  of  exchange,  to  be  sure  a  relatively 
slight  one  in  this  case  because  sterling  was  so  high  when 
thej'  sold  it  in  New  York  it  was  hardly  likely  they  would 
have  to  buy  it  back  at  dearer  rates.  They  took  the  risks 
such  as  they  were  in  connection  with  the  notes.  For  in- 
stance, had  these  notes  suddenly  become  worthless  while 
in  the  ownership  of  our  two  banks,  the  loss  to  these  insti- 
tutions would  have  been  about  one-half  million  dollars. 
The  gain  they  actually  reaped  was  profit.  It  has  the  ap- 
pearance of  something  received  for  nothing.  In  this  it  is 
like  any  other  pure  profit.  To  borrow  cheap  and  lend 
the  same  funds  at  an  advanced  rate  is  a  procedure  open 
to  any  one  with  sufficient  credit  if  opportunity  presents 
itself.  The  mere  commercial  bank  virtually  does  this  when 
it  lends  out  the  fund  constituted  by  its  deposits. 

If  when  October  2d  comes  round  conditions  should  make 
unadvisable  a  termination  of  the  investment  in  XL  notes, 
its  extension  can  be  effected  by  replacing  the  expiring 
long  bill  by  another,  a  species  of  refunding.9  To  explain : 
the  dollars  required  on  October  2d  to  buy  sight  sterling 
cover  for  the  maturing  90  days'  bill  originally  drawn, 
might  be  procured  by  the  sale  of  a  second  90  days'  bill. 
This  postpones   for   a   quarter   the   necessity   of   realizing 

9  Refunding  being  strictly  the  discharge  of  one  long-term,  large, 
and  systematically  issued  debt  by  the  creation  of  another  to  re- 
place it. 


BORROWING  BY  MEANS  OF  EXCHANGE    377 

upon  the  security  in  which  the  fund  transferred  from 
London  has  been  placed.  In  conclusion,  it  may  be  said 
such  extensions  or  renewals  of  virtual  loans  effected  by 
means  of  foreign  bills  are  not  uncommon,  whether  the  opera- 
tion has  been  on  joint-account  or  not. 

§  88.  American  loans  in  foreign  monetary  capitals. — The 
distinction  between  loans  by  means  of  exchange  or  by 
means  of  the  long  bill,  and  ordinary  international  loans 
has  been  explained.  Such  loans  by  means  of  exchange 
as  we  have  considered  have  consisted  in  the  placing  in 
New  York  of  loanable  funds  derived  from  London.  The 
reader  should  understand,  of  course,  that  as  a  mere  mat- 
ter of  mechanism  the  procedure  which  has  been  described 
is  reversible.  If,  for  example,  London  or  Paris  made  a 
practice  of  dealing  in  long  dollar  bills  on  New  York,  they 
could  on  occasion  make  virtual  borrowings  from  our  money 
market  in  quite  the  same  manner  as  we  have  supposed 
New  York  to  borrow  from  London.  Just  at  present  (1919) 
the  New  York  money  market  and  "dollar  exchange"  have 
not  developed  to  the  point  making  this  a  regular  and  well 
known  phenomenon.  On  the  other  hand,  the  making  of 
ordinary  short-time  loans  in  foreign  places  by  American 
banks  is  nothing  new.  Should  money  rates  be  higher  in 
London  than  in  New  Yrork,  an  American  bank  might  place 
funds  in  the  former  city,  but  it  would  have  to  transfer  the 
funds  to  the  place  where  loaned  by  a  remittance  of  sight 
bills  (or  some  equivalent  operation  in  exchange)  and  to 
rc-transfer  them  home  at  the  end  of  the  loan  by  a  sale  of 
sight  bills  (or  some  equivalent).  It  would  thus,  as  an 
actual  lending  institution,  shoulder  the  burden  of  the  ad- 
vance. It  would  be  out  the  use  of  funds  at  home  for  the 
period  for  which  the  foreign  borrower  would  be  having 
their  use.  If  it  made  a  sterling  loan,  it  would  assume  the 
risk  of  exchange;  if  a  dollar  loan,  the  borrower  would 
take  the  risk. 


378  FOREIGN  EXCHANGE 

§  89.  Observations  on  the  "finance  bill." — The  term 
"finance  bill,"  is  comparatively  recent,  but  much  used. 
From  time  to  time  before  the  war  we  would  read  that  "the 
London  market  is  flooded  with  American  finance  bills," 
or  that  "London  bankers  are  discriminating  against  Ameri- 
can finance  bills,"  or  that  "the  Bank  of  England  is  re- 
fusing to  rediscount  bills  for  London  houses  suspected 
of  buying  American  finance  bills."  Opinions  appear 
to  differ  as  to  the  exact  meaning  of  the  term,  but  one 
thing  is  clear,  and  that  is  that  every  finance  bill  is  a 
long  draft  drawn  by  a  banker  or  exchange  house  upon  a 
foreign  banking  or  accepting  house ;  in  brief,  it  is  a  bankers' 
long  bill.  But  not  every  bankers'  long  bill  is  a  finance 
bill.  Thus,  if  a  banker  who  has  purchased  a  non-discount- 
able documentary  payment  draft  draws  his  own  long  bill 
as  a  means  of  recovering  the  cash  thus  laid  out,  it  would 
not  usually  be  held  that  he  created  a  finance  bill. 

As  pointed  out  in  §  35,  the  documentary  payment  bill, 
or  time  bill  on  a  merchant,  with  documents  attached  and 
deliverable  only  in  return  for  payment,  is  subject  to  the 
commercially  recognized  right  of  prepayment  under  rebate, 
and  is  not  discountable  in  the  open  money  market  of  the 
city  on  which  it  is  drawn.  In  England  this  bill  has  not 
even  been  discountable  with  the  correspondent  to  which 
it  is  remitted.  This  is  a  matter  of  English  banking  cus- 
tom. The  American  houses  that  have  purchased  such  in- 
struments have  been  unable  to  realize  sterling  cash  upon 
them  until  maturity,  or  until  the  drawees  have  seen  fit 
at  their  own  options  to  make  prepayment.  One  method, 
however,  of  effecting  an  immediate  recovery  of  the  dollars 
expended  on  this  side  of  the  water  for  such  bills,  is  for 
the  banker  to  sell  his  own  long  bills  against  the  same  as 
collateral.  He  counts  upon  the  proceeds  of  the  documen- 
tary payment  bills,  either  when  prepaid  or  paid  at  ma- 
turity, to  provide  the  funds  to  discharge  the  long  bill  or 


BORROWING  BY  MEANS  OF  EXCHANGE    379 

bills  which  he  has  drawn.  He  can  make  certain  of  this, 
except  in  cases  where  the  insolvency  of  the  drawee  of  a 
documentary  payment  bill  intervenes,  by  seeing  to  it  that 
the  maturity  of  his  own  long  bill  is  as  late  as,  or  later  than, 
the  maturity  of  the  underlying  trade  bills. 

This  type  of  bankers'  long  bill  is  drawn  for  the  purpose 
of  recovering  funds  that  would  otherwise  have  to  remain 
invested  in  certain  exporters'  exchange  that  has  been 
bought.  In  other  words,  the  purpose  is  to  avoid  an  invest- 
ment in  exporters'  bills,  or  to  shift  the  burden  of  the  ad- 
vance, or  the  burden  of  waiting,  to  the  London  money 
market. 

Now  "to  finance"  any  enterprise,  venture,  or  undertak- 
ing, means  to  provide  in  advance  the  necessary  funds  and 
await  the  deferred  return  ultimately  to  be  regained  from 
the  undertaking.  If  an  American  banker  invests  in  an 
American  exporter's  long  bill  on  a  London  consignee,  this 
banker  helps  finance  the  shipment  of  the  goods  in  the  case. 
He  provides  the  exporter  with  present  funds  and  awaits 
a  deferred  return.  But  if,  instead,  our  banker  sells  his 
own  long  bill  against  the  trade  bill  as  collateral,  he  shifts 
the  burden  of  the  advance  to  the  party  in  London  that 
discounts  the  said  banker's  long  bill.  This  case  can  be 
analyzed  as  follows :  our  banker  makes  an  advance  to  our 
exporter  (before  the  importer  has  received  and  paid  for 
the  goods),  but  he  gets  his  cash  back  immediately  from 
some  house  in  New  York  to  which  he  sells  his  own  long 
sterling.  This  house  discounts  the  latter  on  its  arrival 
in  London,  and  has  meanwhile  sold  sight  sterling  in  New 
York  against  it.  Thus  this  house  passes  the  burden  of 
the  advance  on  to  the  money  dealer  in  London  who  has 
made  the  discount.  This  dealer  takes  the  burden  of  the 
advance,  unless  he  shifts  it  to  some  one  else  in  London  by 
rediscount.  Plainly,  then,  the  effect  of  the  banker's  long 
bill  with  which  we  are  at  the  moment  concerned  is  to  make 


380  FOREIGN  EXCHANGE 

London  finance  the  American  export  to  England.  In 
§  44  uc  saw  how  the  sterling  letter  of  credit  system  leads 
to  London's  financing  commercial  shipments  all  over  the 
world.     We  have  here  an  example  of  a  similar  effect. 

Why  not  call  this  class  of  banker's  bills  "finance  bills"? 
Is  not  our  finance  bill  presumably  one  which  makes  the 
foreign  money  market  finance  something  for  us?  The 
answer  is  simply  a  matter  of  usage  of  the  term.  Usage 
excludes  these  particular  bills.  Other  banker's  long  bills 
have  the  effect  of  making  London  finance  some  domestic 
undertaking  of  ours,  while  these  at  any  rate  only  make 
her  finance  our  export,  which  when  it  goes  to  her  is  her 
import  as  much  as  our  export.  Usage  seizes  upon  this 
distinction. 

The  best  definition  of  a  "finance  bill"  then  would  seem 
to  be  the  following:  It  is  any  bankers'  long  foreign  bill, 
except  one  drawn  to  recover  a  fund  already  invested  in 
trade  bills  on  the  same  place  (that  is,  one  drawn  against 
documentary  payment  bills  as  collateral).  It  is  called  a 
finance  bill  because  it  has  the  effect  of  making  the  foreign 
money  market  (London)  finance  some  domestic  under- 
taking of  ours  for  the  term  of  the  bill.  Examples  are  the 
bills  considered  in  our  §§  83,  84,  and  85.10 

itf  In  his  clear,  though,  brief,  "Foreign  Exchange  Explained,"  pp. 
88  and  102,  Mr.  Escher  maintains  that  the  term  "finance  hill"  should 
be  confined  to  the  long  bill  drawn  by  the  borrowing  bank  itself,  the 
bill  considered  by  us  in  §  85.  He  considers  this  "essentially  dif- 
ferent" from  the  bill  drawn  by  a  London  bank's  agent  to  enable 
the  placement  of  a  loan  in  our  market.  But  would  it  not  appear 
that  the  bills  here  distinguished  by  Mr.  Escher  as  "loan"  bills 
and  "finance"  bills  are  formally  different  but  essentially  the  same. 
In  economic  or  financial  nature  and  effect  they  are  the  same.  When 
the  London  bank  takes  the  initiative  in  transferring  loanable  funds 
for  employment  in  our  money  market,  it  is  responsible  for  the  bill 
used  to  effect  the  purpose.  This  does  not  make  the  instrument 
any  the  less  a  finance  bill.  It  merely  removes  any  responsibility 
or  odium  for  it  from  an  American  bank. 


CHAPTER  XIII 
SPECULATION  IN  EXCHANGE 

§  90.  Futures,  speculation,  and  hedging1. — A  sale  of  ex- 
change for  future  delivery  is  a  contract  under  which  one 
of  the  parties  agrees  to  deliver  a  stipulated  amount  and 
kind  of  exchange  (as  £10,000  of  bankers'  sight  sterling) 
upon  a  designated  future  date,  for  a  price  determined 
upon  when  the  contract  is  made,  but  payable  on  the  fu- 
ture date  when  the  exchange  is  actually  delivered.  The 
other  part}r  engages  to  take  the  exchange  at  the  time  and 
price  named.  Both  purchases  and  sales  of  exchange  for 
future  delivery  may  be  made  either  as  speculations  or  as 
means  of  hedging  against  pre-existing  speculations. 

The  term  "speculation,"  in  a  business  sense,  is  often 
taken  to  mean  the  assumption  of  an  unusual  pecuniary 
risk  in  the  hope  of  an  unusual  pecuniary  gain.  But  a 
broader  concept  is  preferable.  It  is  better  to  abandon 
the  test  of  the  unusualness  of  the  chance  taken.  Defined 
formally,  a  speculation  in  a  business  sense  is  the  assump- 
tion of  risk  involved  in  the  making  of  an  outlay  in  money 
(or  money's  worth),  or  the  committing  of  oneself  to  make 
such  an  outlay  in  the  future  (whether  the  commitment 
be  absolute  or  conditional),  for  a  return  in  money  or  its 
worth,  in  any  instance  where  the  relation  or  proportion 
between  the  outlay  and  the  return  is  uncertain.  Outlay 
may  be  certain  and  return  uncertain,  or  reversely,  or  both 
may  be  uncertain,  all  these  combinations  being  common 
in  practice. 

It  is  apparent  that  many  if  not  most  business  under- 

381 


382  FOREIGN  EXCHANGE 

takings  involve  speculation  as  it  is  here  defined.  The 
reader  may  note  that  nothing  in  the  definition  draws  the 
line  between  speculation  and  gambling,  for  in  gambling  a 
person  makes  a  money  outlay  for  an  uncertain  money  re- 
turn. It  is  a  question  of  definition  whether  we  say  gamb- 
ling involves  or  is  speculation  (as  you  prefer),  or  whether 
we  refuse  to  say  it.  "We  shall  not  try  to  settle  this  mat- 
ter but  shall  be  content  to  say  that  our  concern  is  with 
business  speculation,  or  one  kind  of  it — namely  specula- 
tion in  exchange. 

A  speculation  has  been  defined  as  the  assumption  of 
risk  involved  in  a  certain  type  of  operation.  It  is  also 
good  English,  when  convenient,  to  call  the  operation  itself 
a  speculation,  so  that  as  a  manner  of  speech  one  may  say 
indifferently  "the  purchase  of  this  property  involves  a 
speculation"  or  "the  purchase  of  this  property  is  a  specu- 
lation. ' ' 

If  an  operation  involving  a  speculation  is  undertaken 
precisely  for  the  sake  of  this  speculation,  wre  shall  call  the 
operation  an  outright  speculation.  But  if  the  assumption 
of  risk  is  only  secondary  or  incidental  to  some  main  piece 
of  business  wThich  would  be  profitable  in  the  absence  of 
the  risk,  we  shall  call  the  assumption  of  risk  in  such  a 
case  an  incidental  speculation.  Both  outright  and  in- 
cidental speculation  have  important  bearings  on  the  mar- 
ket for  exchange. 

A  hedge — the  dictionaries  seem  to  authorize  only  the 
verb  "to  hedge"  but  let  us  be  high-handed  and  use  the 
noun — a  hedge  is  a  speculation  of  such  character  that  when 
added  to  another  prior  or  more  important  speculation  the 
element  of  risk  in  the  latter  is  either  eliminated  or  reduced. 
A  hedge  and  the  major  speculation  are  of  a  complementary 
character  and  when  merged  in  one  larger  operation  make 
the  whole  less  risky  than  either  element  alone. 

§  91.  Operations  in  futures  as  a  means  of  hedging. — The 


SPECULATION  IN  EXCHANGE  383 

sale  or  the  purchase  of  exchange  for  future  delivery  may 
be  a  hedge. 

For  illustration,  suppose  a  merchant  of  our  country  has 
committed  himself  to  forward  a  certain  kind  and  quantity 
of  goods  to  an  English  buyer  60  days  from  now,  the  price 
to  be  £10,000,  collectable  b}r  means  of  the  American's  draw- 
ing a  sight  draft  for  this  sum  at  the  time  of  the  shipment. 
Suppose  the  exporter's  standing  is  such  that  his  exchange 
always  meets  with  a  ready  sale.  He  has  sold  merchandise 
for  future  delivery.  In  consequence  he  will  have  sight 
sterling  to  sell  in  the  future.  If  he  decides  to  wait  until 
the  day  of  shipping  and  drawing  comes  round,  before  dis- 
posing of  this,  he  will  have  to  take  the  rate  of  exchange 
current  on  that  da}\  Should  this  rate  turn  out  to  be  4.87 
he  would  receive  $48,700,  should  it  be  4.84  his  takings 
would  come  to  but  $48,400,  which  is  $300  less.  Thus  in 
addition  to  any  other  speculations  it  might  embrace,  the 
business  would  certainly  involve  a  speculation  on  the  fu- 
ture course  of  sight  sterling. 

To  avoid,  cancel  out,  or  neutralize  this  speculation,  in 
a  word  to  make  a  hedge  against  it,  it  is  only  necessary  to 
sell  the  £10,000  of  sight  sterling  for  future  delivery.  Sup- 
pose the  engagement  to  sell  the  goods  is  entered  into  on 
July  1st.  They  are  to  be  shipped  on  August  30th.  The 
£10,000  of  sight  sterling  may  be  sold  on  July  1st  for  de- 
livery August  30th  in  return  for  payment  August  30th,  but 
at  a  rate  agreed  to  July  1st.  Suppose  the  buyer  of  this,  the 
exchange  for  future  delivery,  whoever  he  may  be  and 
whatever  his  purpose  may  be,  agrees  to  take  it  at  4.8550. 
His  making  a  contract  to  receive  it  at  this  figure  eliminates 
the  exchange  speculation  from  the  exporter's  operation.1 
This  contrad  sets  in  advance  the  number  of  dollars  to  be 
realized  from  the  goods  by  the  exporter  as  48,550.     It  will 

i  Assuming,  of  course,  the  solvencj  and  ability  of  the  purchaser  of 
the  exchange  for  future  delivery  '.<>  perform  his  agreement. 


3te  FOKEKiN  EXCHANGE 

usually  be  possible  for  the  latter  to  find  the  rate  at  which 
he  can  sell  the  exchange-future  before  he  brings  to  com- 
pletion his  contract  for  the  future  sale  of  the  goods,  in 
which  case  there  is  never  a  moment  when  the  operation 
taken  as  an  entirety  involves  an  exchange  speculation. 

The  sale  of  the  exchange  for  future  delivery  is  in  isola- 
tion an  outright  speculation.  But  combined  with  another 
transaction  to  which  it  possesses  the  proper  complementary 
character,  it  becomes  a  hedge.  The  other  transaction  must 
also  necessarily  be  a  speculation  if  it  stands  alone.  A 
speculation  cannot  be  added  to  a  certainty  and  produce 
the  phenomenon  of  the  hedge,  namely,  the  phenomenon 
of  the  reduction  of  risk  by  the  coupling  on  of  what  in 
isolation  would  itself  be  a  risk. 

One  who  combines  two  speculations  to  form  a  hedge 
becomes  thereby  so  much  the  less  a  speculator.  Much  of 
the  interest  in  the  market  for  exchange  for  future  delivery 
comes  from  parties  that  are  too  conservative  to  speculate 
and  are  interested  because  they  want  to  make  hedges.  A, 
as  the  seller,  and  B,  as  the  buyer  of  the  future  exchange, 
may  both  be  hedging.  These  are  parties  that  are  well  met. 
B  might  be  an  exchange  dealer  who  had  sold  long  sterling 
for  which  he  needs  to  buy  in  sight  sterling  as  cover  on  or 
about  August  30th.  His  purchase  of  this  in  advance  at 
4.8550,  removes  the  speculation  on  the  sight  rate  from 
his  operation. 

§  92.  Going  long  of  exchange. — All  methods  of  making 
a  profit  from  a  speculation  in  any  marketable  article — 
wheat,  cotton,  stocks,  exchange — reduce  to  one  funda- 
mental operation,  buying  a  thing  cheaper  and  selling  it 
dearer.  "When  the  speculator  "goes  long"  he  buys  first 
and  sells  afterward.  AYhen  he  goes  short  he  sells  first 
and  buys  afterward.  In  the  one  case  he  profits  from  a 
rise,  in  the  other  from  a  fall,  in  the  price  while  he  is  op- 
erating or  speculating. 


SPECULATION  IN  EXCHANGE  385 

In  a  strict  sense  one  goes  short  only  in  case  he  sells  some- 
thing he  does  not  already  have  on  hand  or  in  stock.  Either 
the  sale  must  be  for  future  delivery,  or,  if  for  immediate 
delivery  the  article  or  articles  must  be  borrowed  for  this 
delivery  and  the  short-seller  will  thus  come  to  owe  them 
to  the  lender,  to  be  delivered  at  some  future  time  or  upon 
demand.  Thus  to  go  short  means  to  go  under  a  contract 
to  deliver  something  in  the  future  without  now  having  it 
on  hand,  or  to  go  under  a  commitment  of  some  kind  to 
deliver  or  find  this  something  not  now  on  hand.  Such  a 
commitment  is  not  necessarily  an  express  contract  to  de- 
liver this  thing  to  some  person,  but  may  be  any  condition 
of  practical  compulsion  to  find  the  thing.  Thus  a  manu- 
facturer of  some  product  may  by  reason  of  sales  of  it  for 
future  delivery  put  himself  short  of  the  raw  material 
from  which  it  is  made,  without  this  signifying  that  he  has 
made  a  contract  to  deliver  this  very  substance  to  any  per- 
son. So  again  the  banker  who  has  sold  his  long  sterling 
bill  puts  himself  short  of  sight  sterling  or  of  cables,  no 
matter  which,  insomuch  as  he  places  himself  under  the 
necessity  of  finding  this  for  cover  at  a  future  date. 

If  a  man  having  500  shares  of  AB  stock  should  sell  out 
100  shares  on  a  given  date  because  he  thought  the  price 
higher  then  than  it  would  be  subsequently,  and  should 
succeed  later  in  buying  back  the  same  quantity  at  a  lower 
figure  and  therefore  at  a  profit,  he  would  not  have  been 
short  of  AB  in  a  technical  sense.  He  would  be  like  a 
short  in  that  he  profits  by  the  same  movement  of  prices 
that  would  benefit  a  short,  but  he  would  not  be  confronted 
with  a  certain  danger  that  lurks  in  the  position  of  a  short. 
The  latter  can  conceivably  be  caught  in  a  corner,  while  the 
man  who  has  sold  from  stock  on  hand  cannot. 

Dealers  in  bills  often  k<>  short  of  exchange  in  the  true 
technical  sense,  so  that  they  place  themselves  under  1 1n- 
positive  necessity   of   procuring   this   article   at    some   sub 


386  FOREIGN  EXCHANGE 

sequent  date,  hoping  of  course  to  do  so  cheaply  and  at 
a  profit  but  being  open  to  unavoidable  losses  in  case  the 
course  of  exchange  should  go  against  them.  It  is  now  our 
province  to  consider  in  a  little  more  detail  the  methods 
of  going  long  of  exchange. 

Pure  speculation  in  exchange  on  the  long  side. — By  a 
pure  speculation  we  mean  one  not  compounded  with  in- 
vestment or  borrowing.  The  only  way  a  dealer  can  make 
a  pure  speculation  in  exchange  on  the  long  side  is  to  buy 
exchange  for  future  delivery,  wait  till  he  receives  it  on 
the  designated  future  date,  and  then  sell  it  at  the  market. 
Suppose  that  on  March  1st  dealer  A  makes  a  contract 
with  B  to  take  £5,000  of  bankers'  sight  bills  from  the 
latter  on  April  15th  at  the  rate  of  4.8550.  He  has  bought 
a  future.  He  pays  out  no  money  and  receives  none  on 
March  1st,  and  thus  has  neither  made  an  investment  nor 
received  an  advance.  He  has  taken  a  chance  on  purpose 
because  he  regarded  it  as  a  good  chance,  and  has  thus  made 
what  we  have  called  an  outright  speculation.  If  on  April 
15th  sight  sterling  should  happen  to  stand  at  4.8750  in 
the  market,  he  has  made  a  good  speculation.  For  on  that 
day  B  must  deliver  him  £5,000  at  4.8550.  This  will  cost 
him  $24,275.  It  can  immediately  be  sold  at  4.8750  for 
$24,375,  or  at  a  profit  of  $100,  which  is  a  return  for  noth- 
ing else  than  making  a  commitment  and  taking  a  risk. 
If  the  market  rate  on  April  15th  had  turned  out  to  be  un- 
der 4.8550,  our  operator  would  have  made  a  loss,  insomuch 
as  he  is  then  compelled  to  pay  more  for  the  bills  which 
he  must  buy  than  they  would  cost  in  the  market.  If  the 
other  party,  B,  were  a  speculator,  he  would  gain  in  this 
case,  as  he  could  buy  in  the  market  and  resell  to  A  at  the 
higher  figure  named  in  the  contract.  However,  B  may 
not  have  been  a  speculator,  but  some  one  engaged  in  hedg- 
ing. 

Operations   on   the   long   side   involving   investment   or 


SPECULATION  IN  EXCHANGE  387 

lending. — All  other  methods  of  going  long  of  exchange 
than  the  isolated  operation  of  buying  a  future,  by  neces- 
sity involve  either  an  investment  in  exchange  or  the  mak- 
ing of  a  foreign  loan. 

(1)  Let  us  consider  first  an  illustration  of  a  speculation 
on  the  long  side  associated  with  an  investment  in  exchange. 
It  is  true  this  leads  us  into  what  is  essentially  a  repetition 
of  an  illustration  already  given,  the  one  of  an  investment 
in  exchange,  but  it  is  worth  while  to  look  at  the  same 
thing  anew  and  from  a  different  standpoint.  If  sight 
sterling  is  very  low  at  present  and  a  dealer  thinks  it  will 
be  materially  higher  in  60  days,  a  feasible  way  for  him 
to  go  long  and  speculate  for  the  rise,  is  to  buy  some  60 
days'  bills  and  hold  them  till  maturity  (i.e.,  invest  in 
them).  He  might  of  course  close  out  at  some  earlier  time 
than  the  very  end  if  he  thought  it  best,  and  this  by  dis- 
counting the  bills  in  London  before  their  maturities. 
Suppose  the  following  data  are  given  on  March  1st. 

Sight   sterling    4.84 

London  arrival  discount  rate 3% 

60  days'  bills  therefore  at 4.8125 

And  suppose  the  following  proves  true  on  May  3d. 
Sight  sterling    4.88 

This  gives  us  a  very  favorable  case.  Let  us  see  what 
comes  out  of  it.  A  New  York  dealer  goes  long  on  March 
1st  by  purchasing  £10,000  of  60  days'  bills  at  a  cost  of 
$48,125.  Allowing  these  to  run  till  maturity  without  dis- 
counting them  in  London,  he  is  enabled  to  sell  £10,000 
of  sight  sterling  on  May  3d  against  them  as  cover.  At 
4.88  this  fetches  him  $48,800.  His  return  exceeds  his  out- 
lay by  $675.  This  gain  is  attributable  chiefly  to  the  very 
fortunate  speculation  on  the  course  of  the  sight  rate.  To 
isolate  what  we  may  regard  as  the  speculative  profit  we 


388  FOREIGN  EXCHANGE 

would  need  to  suppose  that  the  sight  rate  remained  on  May 
3d,  where  it  was  on  March  1st,  that  is  at  4.84.  In  this 
case  the  return  from  the  operation  would  have  been  $48,- 
400  and  the  gain  but  $275.  The  actual  gain  exceeds  this 
by  $400. 

It  was  first  asserted  some  time  back  that  every  invest- 
ment in  exchange  involves  a  speculation  on  the  course  of 
the  rate  of  exchange.  We  now  see  the  same  fact  from 
another  angle,  for  we  see  that  whenever  an  operator 
speculates  on  the  long  side  by  the  method  of  purchasing 
30,  60,  or  90  days  bills,  the  speculation  necessarily  involves 
an  investment.  The  difference  between  an  investment  in- 
volving a  speculation  and  a  speculation  involving  an  in- 
vestment is  simply  one  of  degree.  The  question  is  merely 
which  element  the  operator  regards  as  the  main  one.  Con- 
ditions might  suggest  investment  if  it  were  not  for  a  very 
bad  incidental  speculation.  For  instance  money  rates 
might  be  very  low  in  New  York  and  high  in  London,  but 
the  sight  rate  on  London  might  be  so  high  now,  and  be 
associated  with  prospects  of  being  so  much  lower  later, 
that  investment  would  be  counter-indicated  and  restrained. 

(2)  A  banker  may  go  long  of  exchange  by  making  loans 
to  foreigners  in  foreign  money,  by  placing  a  franc  loan 
in  Paris  or  a  sterling  loan  in  London.  He  will  profit  by 
having  the  value  of  the  foreign  money  in  terms  of  our 
money,  as  expressed  in  the  exchange  rates,  low  when  he 
places  the  loan  and  high  when  it  matures.  It  is  conceivable 
he  should  place  the  loan  not  primarily  because  interest 
rates  were  high  in  the  foreign  capital  but  primarily  be- 
cause the  speculation  on  the  exchange  rate  seemed  attrac- 
tive, in  which  case  we  would  have  a  speculation  in  foreign 
exchange  on  the  long  side  coupled  with  a  loan  abroad  as 
an  important  incident. 

Usually  such  speculations  would  not  cover  a  long  period 
and  involve  the  purchase  of  long-term  foreign  securities. 


SPECULATION  IN  EXCHANGE  389 

But  if  before  the  military  collapse  of  Eussia  in  the  World 
War  some  one  should  have  advised  Americans  with  money 
to  buy  Russian  government  bonds  on  the  grounds  that 
the  ruble  had  a  very  low  value  in  dollars  at  the  time 
and  would  probably  have  a  much  higher  one  some  time 
in  the  future,  when  the  bonds  might  be  sold  to  advantage 
in  Russia,  this  some  one  would  be  advising  going  long  of 
Russian  exchange.  At  the  present  writing  (1919)  it 
would  appear  that  such  advice  would  have  been  very  bad. 

It  would  be  possible  for  a  dealer  to  go  long  of  some 
kind  of  exchange,  sterling,  for  instance,  by  purchasing 
sight  drafts  to  be  remitted  for  the  credit  of  the  London 
deposit,  allowing  the  fund  so  established  to  remain  un- 
touched for  a  time,  and  then  selling  sight  drafts  against 
it  later.  This  would  essentially  be  an  example  of  a 
speculation  involving  a  loan,  because  our  deposits  in  Lon- 
don are  virtual  demand  loans  to  London  banks.  But  this 
method  of  speculating  for  a  rise  in  the  rate  for  sterling 
in  New  York  could  only  be  appropriate  when  a  rather 
sharp  rise,  or  considerable  rise  in  a  brief  time,  is  expected. 
This  is  because  the  rate  of  interest  received  on  London 
balances  is  so  low  that  a  loan  at  that  rate  is  per  se  an 
unremunerative  employment  of  funds.2 

§  93.  Going  short  of  exchange. — There  is  but  one  way 
to  make  a  pure  speculation  in  exchange  on  the  short  side, 
or  for  the  fall.  This  is  to  make  a  sale  for  future  delivery 
as  an  independent  and  isolated  operation,  and  wait,  if  not 

2  Any  one  having  some  special  credit  abroad  against  which  he  is 
entitled  to  draw  sight  exchange,  may  defer  the  sale  of  this  for  a 
time  because  of  a  belief  the  rate  for  it  will  be  higher  later  on 
than  now.  But  a  speculation  for  the  rise,  of  this  character,  is  not 
likely  to  be  undertaken  with  the  intention  that  it  shall  endure  verj 
long,  this  because  of  the  loss  of  interest  entailed.  If  an  exporter 
entitled  to  sell  sight  or  long  bills  at  the  present  moment  should 
hold  off  for  a  few  days  on  the  theory  that  a  rise  is  imminent,  be 
would  be  engaging  in  a  mild  speculation  on  the  long  side. 


390  FOREIGN  EXCHANGE 

until  tlic  day  set  for  delivery,  at  least  for  a  certain  time, 
before  buying  in  the  exchange  to  be  used  to  discharge  the 
contract.  During  this  period  the  dealer  remains  short 
without  the  speculation's  being  alloyed  with  any  opera- 
tion with  a  finance  bill  or  other  borrowing  operation.  As- 
suming him  to  remain  short  until  the  day  of  maturity  of 
the  contract  (though  he  might  conclude  to  purchase  cover 
at  an  earlier  date),  his  profit  or  loss  will  depend  on  the 
relation  of  the  market  rate  of  that  day  to  the  rate  at  which 
he  sold  for  future  delivery.  Thus  if  he  sold  for  4.86  and 
buys  in  cover  at  4.84  on  the  day  of  delivery,  his  profit  as 
a  speculator  is  evidently  2e"  a  pound  or  $200  on  a  £10,000 
contract.  It  is  clear  that  like  other  shorts,  he  is  interested 
in  seeing  a  low  price  on  that  day  in  the  future  when  he 
is  to  cover. 

Operations  on  the  short  side  by  means  of  long  bills. — 
We  have  already  seen  (§85)  that  if  a  banker  sells  a  long 
sterling  bill  he  is  by  this  action  put  short  of  sight  sterling 
(though  sterling  cables  might  be  bought  in  later  as  a  sub- 
situte).  How  this  banker  comes  to  enjo3r  a  virtual  loan 
made  him  from  the  London  money  market  has  already 
been  explained.  Heretofore  we  have  looked  upon  the 
speculation  in  sight  exchange  on  the  short  side  which  is 
associated  with  this  operation  as  the  incidental  feature. 
But  there  may  be  occasions  when  the  operation  is  under- 
taken not  so  much  because  the  local  money  rates  are  higher 
than  those  of  London  as  because  the  speculation  is  allur- 
ing. This  gives  us  the  case  of  speculation  on  the  short 
side  with  borrowing  as  an  incident,  which  contrasts  with 
what  we  have  called  a  "pure"  speculation.  Formerly 
the  United  States  was  accustomed  to  make  exceedingly 
heavy  exports  of  commodities  in  the  autumn  of  each  year, 
which  produced,  as  a  fairly  regular  and  predictable 
phenomenon,  a  great  drop  in  the  rates  for  sterling  in  New 
York  in  that  season  of  the  year,  the  huge  and  concentrated 


SPECULATION  IN  EXCHANGE  391 

supplies  of  exporters'  foreign  bills  being  the  technical  ex- 
planation.3 Extensive  sales  of  long  sterling  from  two  to 
three  months  before  this  expected  movement  were  very 
common.  These  sales  were  examples  of  what  we  are  at  the 
present  moment  describing,  going  short  of  sterling  ex- 
change to  reap  a  profit  from  its  fall,  the  means  being  the 
sale  of  long  bills.  This  style  of  operation  may  be  expected 
to  remain  prominent  whenever  and  so  long  as  our  export- 
ing shows  the  kind  of  periodicity  which  explains  it. 

§  94.  Recovery  of  funds  laid  out  for  documentary  pay- 
ment bills. — Merchants'  long  bills  with  documents  at- 
tached deliverable  against  payment  by  the  drawee,  are 
subject  to  the  right  of  prepayment  by  the  latter  under  the 
retirement  rate  of  discount.  Bills  of  this  character  drawn 
on  England  are  not  discountable  on  their  arrival  either 
with  the  correspondent  bank  or  in  the  open  market.  Each 
individual  bill  will  convert  into  sterling  cash  on  that  par- 
ticular date  after  arrival  and  acceptance,  when  the  drawee 
at  his  option  choses  to  prepay  it  or  take  it  up.  And  then 
the  amount  it  will  yield  will  depend  upon  the  retirement 
rate  of  discount  of  that  particular  day.  At  the  latest  it 
will  be  paid  on  its  date  of  maturity,  if  the  drawee  has  not 
seen  fit  to  exercise  the  right  of  prepayment,  and  will  then 
yield  its  face  value.4  This  discussion  holds,  of  course,  on 
the  assumption  that  there  is  no  dishonor  of  the  bill  by  the 
drawee. 

The  consequence  of  these  facts  is  that  an  exact  "no- 
profit"  buying  price  (to  which  the  banker  might  add 
profits  at  the  rate  he  decides  on  according  to  degree  of 
security,    competition,    etc.)    simply    cannot    be    computed 

3  Tin-  majority  of  these  bills  would  be  drawn  on  England  and  in 
sterling,  ljui  even  those  drawn  in  other  currencies,  through  the 
influence  of  arbitrage  (see  Chapter  XIV)  contributed  aH  cll'ectually 
to  the  main  result. 

*  Compare  §  67. 


392  FOREIGN  EXCHANGE 

for  the  individual  documentary  payment  bill.  Tf  a  given 
D.  P.  bill,  offered  on  this  side  to-day,  were  destined  to  be 
prepaid  on  arrival,  and  we  knew  this  in  advance  and  also 
knew  what  the  retirement  rate  of  discount  would  be  at 
the  time,  we  could  compute  a  no-profit  buying  price  for  it 
with  the  same  ease  and  accuracy  as  for  the  discountable 
types  of  exchange,  and  according  to  the  methods  which 
apply  to  the  latter  as  explained  in  Chapter  IX.  If  the 
bill  in  question  were  destined  to  be  prepaid  30  days  after 
arrival,  at  the  same  or  at  some  other  retirement  rate  of 
discount,  it  would  have  a  different  theoretical  value  in 
dollars  as  a  purchase  to-day,  and  if  it  were  to  be  allowed 
to  run  till  maturity,  still  another  value. 

Documentary  payment  bills  that  are  drawn  against 
perishable  goods,  which  must  be  procured  promptly  by  the 
drawee,  have,  of  course,  an  excellent  chance  of  early  pre- 
payment, and  the  banker  may  take  this  into  his  reckoning, 
but  speaking  of  the  generality  of  these  bills,  the  precise 
theoretical  no-profit  or  basic  buying  rate  for  each  individ- 
ual instrument  cannot  be  determined. 

When  a  banker  takes  such  a  bill  for  collection,  the  un- 
certainties pertaining  to  it  do  not  of  course  become  his 
problem,  but  remain  the  concern  of  the  drawer  or  ex- 
porter. Bankers,  however,  make  outright  purchases  of 
these  bills  in  large  numbers,  and  in  consequence  have  re- 
sorted to  special  methods  of  handling  them  which  it  is  now 
our  province  to  describe  if  only  in  a  brief  way.  Since  in 
some  instances  sales  of  the  banker's  own  long  bills,  and 
in  others  sales  of  demand  drafts  for  future  delivery  are 
involved,  this  discussion  has  been  postponed  to  this  point 
instead  of  having  been  undertaken  in  Chapter  IX. 

If  the  banker  who  buys  a  documentary  payment  bill 
is  willing  to  lock  up  the  funds  paid  for  it,  until  it  is  in 
the  course  of  events  discharged  abroad,  and  is  willing  to 
take  a  speculation  as  to  the  rate  at  which  he  can,  after 


SPECULATION  IN  EXCHANGE  393 

being  notified  of  its  retirement,  sell  demand  sterling  or 
cables  against  it,  he  need  take  no  special  action  in  con- 
nection with  it.     But  since  this  procedure  involves  both 

(1)  a  postponement  of  the  recovery  of  funds  and  (2)  an 
exchange  speculation,  it  is  often  not  altogether  satisfac- 
tory. An  additional  speculation  as  to  the  future  course 
of  the  retirement  rate  of  discount  is  likewise  involved,  this 
being  in  fact  ineradicable. 

The  two  special  plans  of  action  which  serve  as  partial 
solutions  of  the  difficulties  are  (1)  the  sale  of  the  banker's 
own  long  bills  against  the  purchased  documentary  pay- 
ment bills  as  collateral   for  the  acceptance  account,   and 

(2)  the  sale  of  demand  bills  for  future  delivery  accord- 
ing to  a  schedule  of  probable  prepayments  of  the  mass  of 
documentary  payment  bills  bought  and  held  abroad.  The 
first  has  the  advantage  of  bringing  about  an  immediate 
recovery  of  funds,  while  the  second  reduces  the  speculation 
as  to  the  future  course  of  sterling  rates  in  our  market. 

To  speak  of  these  in  a  little  more  detail  and  in  order, 
the  London  correspondent  banker  or  acceptance  house  upon 
which  our  bank  will  draw  its  long  bills,  almost  always  re- 
quire collateral  security  for  the  grant  of  their  acceptances.5 
Documentary  payment  bills  are  freely  received  as  such 
collateral.  Now  then,  if  our  bank  has  some  of  these 
abroad  it  may  find  it  an  advantage  to  draw  its  own  long 
bills  in  such  amounts  and  maturities  that  the  collections 
from  the  documentary  payment  bills  will  furnish  the 
sterling  required  for  the  discharge  of  the  same,  meanwhile 
pledging  the  documentary  payment  bills  as  collateral  to 
protect  the  acceptance  account.  It  is  necessary  that  the 
latter  should  be  paid  early  enough  to  cover  the  banker's 
long  bill  drawn  against  them,  and  therefore  presumably 
they  should  all  have  maturity  dates  on  or  before  the  due 

5  Compare  §  40. 


394  FOREIGN  EXCHANGE 

date  of  this  bill.  If  they  happen  to  be  prepaid  no  harm 
follows  except  a  loss  of  interest  due  to  the  difference  be- 
tween the  retirement  rate  and  the  deposit  allowance  rate. 

It  is  not  customary  for  bankers  to  think  of  such  of  their 
long  drafts  as  are  drawn  against  previously  purchased 
documentary  payment  exchange,  as  being  "finance  bills."6 
For  the  bills  that  bear  this  name  are  drawn  not  to  recover 
moneys  previously  laid  out  in  the  purchase  of  sterling  ex- 
change, but  to  secure  new  funds  for  free  employment  dur- 
ing 60  or  90  days  or  more.  The  distinction  has  a  tech- 
nical banking  validity,  though  in  both  cases  London 
finances  us.  London  finances  our  exports  to  England  in 
the  one  instance.  In  the  other  its  accommodation  is  for 
an  unidentified  purpose,  the  purpose  to  which  the  drawer 
of  the  finance  bill  happens  to  devote  the  funds  he  secures 
by  means  of  it. 

One  of  our  bank's  holding  a  quantity  of  documentary 
payment  bills  abroad  may  be  able  on  the  basis  of  its  ex- 
perience to  draw  up  a  schedule  of  probable  prepayments 
to  come  from  the  whole  mass  of  them,  despite  the  fact  it 
cannot  predict  the  dates  of  prepayment  of  each  individual 
instrument.  In  giving  an  illustration  of  this,  Margraff T 
supposes  that  bills  held  abroad  which  will  produce  about 
£50,000  in  total,  will  yield  £10,000  fifteen  days  after  ar- 
rival, £20,000  on  the  thirtieth  day,  and  £20,000  more  be- 
tween the  forty-fifth  and  sixtieth.  On  the  basis  of  this 
schedule  the  banker  may  sell  demand  sterling  for  future 
delivery,  to  wit,  £10,000  for  the  15th  day  after  purchase, 
£20,000  for  the  30th  day  and  so  on.  There  is,  to  be  sure, 
a  certain  degree  of  speculation  left  in  this  business.  If 
prepaj^ments  should  prove  slower  than  the  schedule,  over- 
drafts might  be  incurred,  and  if  they  prove  faster,  the 
returns  will  be  affected  to  a  degree,  but  the  major  specula- 

e  Compare  §§  85  and  89. 

i  In  his  "International  Exchange,"  p.  56. 


SPECULATION  IN  EXCHANGE  395 

tion  as  to  the  future  course  of  sterling  in  this  country  is 
eliminated.  The  reader  understands,  of  course,  that  the 
scheme  is  to  have  the  proceeds  from  the  documentary  pay- 
ment bills,  as  they  are  taken  up  abroad,  provide  for  the 
discharge  of  the  demand  drafts  promised  for  future  de- 
livery here. 

It  is  not  our  intention  to  press  further  into  this  sub- 
ject. Thus  we  pass  over  the  technical  problem,  faced  by 
the  exchange  banker,  of  figuring  the  exact  rates  which  he 
can  offer  for  documentary  payment  bills,  under  these  plans 
of  handling  them.  The  basic  factors  that  must  be  taken 
into  account  here  are  the  probable  net  returns  at  home 
in  dollars  to  be  had  from  the  documentary  payment  bills, 
the  time  of  their  receipt,  and  if  this  is  a  future  time  (as 
when  exchange  for  future  delivery  is  sold)  the  rate  of 
interest  to  be  charged  the  operation  meanwhile. 

Beneath  appears  a  conspectus  of  the  sources  of  supply 
and  demand,   for  exchange  for  future  delivery. 

The  Supply  of  Futures  Comes  From 

1.  Operators  who  go  short  of  exchange  as  an  outright 

speculation. 

2.  Bankers  who  have  invested  in  long  foreign  bills. 

3.  Merchants  who  have  sold  goods  abroad  for  future  de- 

livery. 

Exporters  of  goods  for  future  delivery  or  mer- 
chants who  for  any  reason  know  in  advance  thai 
they  will  have  exchange  to  offer  in  the  future,  may 
sell  it  for  future  delivery  to  eliminate  specula!  ion. 

4.  Bankers  who  have  purchased  a  line  of  documentary 

paymenl   hills. 

These  bankers  may  offer  futures  againsl  an  as- 
sumed schedule  of  payments  and  prepayments  as 
explained  just  above. 


396  FOREIGN  EXCHANGE 

The  Demand  for  Futures  Comes  From 

1.  Operators  who  engage  in  an  outright  speculation  on 

the  long  side. 

2.  The  drawers  of  finance  bills. 

3.  Merchants  who  have  purchased  foreign  goods  for  fu- 

ture delivery  and  whose  arrangements  for  payment 
are  such  that  they  can  reduce  speculation  by  buy- 
ing some  type  of  exchange  for  delivery  on  a  fu- 
ture date  appropriate  to  their  undertaking. 


CHAPTER   XIV 

ARBITRAGE 

Foreword. — Arbitrage  of  Exchange  is  a  very  tech- 
nical SUBJECT  AND  CAN  ONLY  BE  TREATED  TECHNICALLY.  A 
COMPETENT  EXPLANATION  OP  IT  CANNOT  MERELY  BE  READ  BUT 
MUST   BE   STUDIED. 

§  95.  Arbitrage  and  arbitrated  rates,  parities,  and  prices. 
— The  term  "arbitrage  of  exchange"1  signifies  either 

1.  An  exchange  operation  of  a  certain  kind,  or 

2.  A  mere  exchange  reckoning  or  calculation  of  a  cer- 
tain kind. 

A  set  definition  of  an  arbitrage  operation  is  a  thing  so 
formidable  that  we  will  do  best  to  give  a  mere  illustra- 
tion our  first  attention.  Suppose  a  New  York  banker  has 
telegraphic  information  of  the  fact  that  cable  transfers 
on  London  are  now  selling  in  Paris  at  the  rate  of  25.15 
francs  per  pound  sterling.  At  New  York  the  rate  for 
cables  on  London  is  4.87,  while  that  for  cables  on  Paris 
is  5.17^  meaning  that  5.17^  francs  can  be  purchased  for 
$1.     Thus 

London 

Hew  York 
Cables  on  London      4.87 
Cables  on  Paris        5.17-^ 

Paris 
Cables  on  London      25.15 


i  Also  known  as  arbitration   of  exchange. 

397 


.i.is  FOREIGN  EXCHANGE 

The  relation  between  these  rates  makes  possible  the  win- 
ning of  a  slight  prolit  from  what  is  known  as  a  "three- 
point"  arbitrage  operation.  Suppose  that  the  operator 
is  at  New  York  and  for  simplicity's  sake  that  he  works 
with  $100.  By  aid  of  his  tables  or  of  a  brief  computation 
he  soon  determines  what  to  do. 

1.  lie  first  expends  the  $100  for  a  cable  transfer  on  Paris. 

At  the  rate  quoted  this  would  buy  517.50  francs  of  such 
exchange  and  enable  him  to  establish  almost  instantane- 
ously a  credit  for  this  amount  with  his  Paris  correspond- 
ent. 

2.  He  next  instructs  his  Parisian  correspondent  to  expend  the 
credit  in  francs  for  a  sterling  cable,  to  be  bought  at  Paris. 

517.50  francs  will  at  the  rate  of  25.15  purchase  205yioo 

pounds  of  cable  transfer  on  London. 

(517.50^25.15  =  20.57) 
This  sterling  is  placed  to  the  credit  of  our  operator's  ac- 
count with  his  London  correspondent. 

3.  Finally   he   sells   £20.57   of   sterling    cables   in   New    York 
for  $100.17. 

£20.57  sold  at  4.87  bring  in  $100.17. 

The  operation  consists  of  three  transactions. 

1.  A  conversion  of  dollars  into  francs  by  the  purchase  of  a 

cable  on  France  (which  is  not  the  only  way  to  make  this 
conversion) 

2.  A  conversion  of  francs  into  pounds  by  the  purchase  at  Paris 

of  a  cable  on  London  (which  again  is  not  the  only  way 
to  effect  such  a  conversion) 

3.  A  conversion  of  pounds  into  dollars  by  a  sale  at  New  York 

of  a  cable  on  London  (which  also  is  not  the  only  way  to 
effect  such  a  conversion) 

The  operator  laid  out  $100  and  got  back  $100.17,  mak- 
ing a  gross  profit  of  11$  or  about  l-6th  of  1%.  Out  of 
this  telegraphic  charges  and  other  incidental  expenses 
must  be  paid.     The  gross  profit  would  be  $170  on  an  op- 


ARBITRAGE  399 

eration  with  $100,000,  and  an  operator  who  could  make 
a  profit  at  this  rate  would,  we  are  given  to  understand, 
consider  himself  very  fortunate  indeed. 

Arbitrage  operations  assume  such  a  variety  of  forms 
that  a  definition,  which,  will  at  once  include  all  these  op- 
erations and  exclude  every  kind  that  is  not  arbitrage,  neces- 
sarily becomes  lengthy  and  complex.  In  offering  the  fol- 
lowing we  do  not  mean  to  suggest  that  the  reader  can  gain 
from  it  an  understanding  of  arbitrage  without  thorough 
illustration.  Speaking  now  of  arbitrage  of  foreign  ex- 
change as  an  operation,  we  may  say  this  is  an  operation 
conducted  by  a  dealer  in  a  given  country,  which  always 
involves  a  purchase  or  sale  of  foreign  exchange  for  his 
account  in  another  country  or  in  other  countries,  and  con- 
sists in  an  outlay  of  funds  at  home  to  purchase  exchange 
on  some  foreign  country  and  a  return  of  funds  to  the 
home  office  either  (1)  from  the  sale  of  exchange  on  some 
different  foreign  country  or  (2)  from  the  receipt  from 
abroad  of  a  remittance  of  exchange  payable  or  salable 
in  the  home  country,  the  operation  being  undertaken  to 
make  a  profit  from  an  excess  of  the  return  over  the  out- 
lay which  has  become  possible  owing  to  the  relative  posi- 
tions of  the  several  exchange  rates  governing  the  transac- 
tion. The  outlay  and  the  return  in  an  arbitrage  opera- 
tion take  place  as  nearly  simultaneously  as  possible,  but 
the  outlay  may  precede  the  return,  or  the  return  precede 
the  outlay.  The  one  who  operates  is  called  an  "arbitrager" 
or  an  "arbitrageur." 

If  the  operation  embraces  exchange  transactions  in  two 
places  only  it  is  known  as  "two-point"  arbitrage.  If 
transactions  in  three  places  are  involved,  we  have  ''three- 
point"  arbitrage,  and  so  forth.  The  example  we  con- 
sidered a  moment  ago  was  one  of  three-point  arbitrage. 
(See  §99). 

Arbitrage  of  foreign  exchange  (we  speak  as  well  of  ar- 


400  FOREIGN  EXCHANGE 

bitrage  of  stocks  and  bonds)  may  also  be  defined  as  the 
taking  of  a  fund  in  the  currency  of  one  country,  and  the 
conversion  of  it  by  means  of  a  transaction  in  exchange 
into  a  currency  of  another  country,  and  the  re-conversion 
of  it  into  the  original  or  home  currency  by  another  trans- 
action in  exchange — or  the  conversion  of  it  into  the  cur- 
rency of  a  third  or  even  of  a  fourth  country  and  the  final 
re-creation  of  it  as  a  fund  in  the  home  currency  by  fur- 
ther transactions  in  exchange — with  a  view  to  having  the 
returned  fund  exceed  the  one  started,  when  this  result 
is  made  possible  by  the  relative  positions  of  exchange 
rates.  A  fund  is,  so  to  say,  sent  out  on  a  circular  journey 
and  reappears  as  a  slightly  larger  one  in  its  original  cur- 
rency.    (Compare  §  96  on  the  transfer  of  funds). 

Arbitrage  as  a  computation. — The  preceding  has  re- 
ferred to  arbitrage  as  an  operation.  But  the  term  also 
means  a  mere  computation,  the  computation  of  what  is 
often  called  a  "par"   or  "parity."     For   example, 

A  certain  stock  sells  in  London  at £  33.      a  share 

Sight  sterling  in  New  York  is  at 4.87 

The  New  York  price  of  this  stock,  which  is  the 
equivalent  of  the  London  price  for  trading 
purposes,  must  be  based  on  tbe  rate  of 
exchange  and  will  be   $160.71  a  share 

Whether  the  sight  or  cable  rate  should  be 
employed  in  any  given  computation  de- 
pends on  the  nature  of  the  transaction  to 
which  it  relates. 

The  $160.71  per  share  is  an  arbitrated  price  or  arbitrated 
par  or  parity.  It  is  distinct  from  the  actual  price  in  New 
York  from  which  it  may  differ  at  any  moment.  A  gap 
between  the  two  is  in  fact  what  leads  to  an  arbitrage  op- 
eration in  the  stock,  while  the  continual  succession  of  such 
operations  is  what  tends  to  drive  the  two  prices,  the  ar- 


ARBITRAGE  401 

bitrated  and  the  actual,  together  or  make  them  coalesce. 

If  we  speak  of  the  London  price  for  some  article,  ex- 
pressed as  it  is  in  sterling,  and  the  New  York  price  ex- 
pressed in  dollars,  as  being  equivalent  or  equal  or  at  an 
equality  or  at  a  parity,  the  one  rational  meaning  our 
statement  can  have  is  that  the  arbitrated  price  and  the 
actual  price  in  one  of  these  cities  are  the  same.  If  we  say 
"Atchison  is  higher  in  London  than  in  New  York"  this 
means  practically  that  New  York's  arbitrated  price  from 
London  is  higher  than  New  York's  actual  price.  It  is 
solely  by  the  comparison  of  the  arbitrated  and  the  actual 
prices  in  our  currency  that  our  dealers  can  tell  whether 
to  buy  the  stock  in  New  York  and  sell  in  London,  or  do 
the  reverse,  or  do  nothing. 

An  arbitrated  price  is  then  the  price  of  an  article  in 
one  country  and  in  the  currency  of  that  country  con- 
verted to  a  price  in  terms  of  the  currency  of  another  coun- 
try, the  conversion  being  effected  by  means  of  the  ratio 
afforded  by  the  existing  exchange  rate  between  the  two 
countries.  The  exchange  rate  may  be  the  sight  or  cable 
rate  and  may  be  taken  from  the  exchange  market  of  either 
one  of  the  cities,  according  to  circumstances.  It  should 
be  understood  that  in  times  of  free  intercourse  the  two 
cable  rates  (the  one  in  the  first  country  on  the  second  and 
the  one  in  the  second  on  the  first)  tend  to  rest  at  exactly 
the  same  value  ratio  between  the  two  currencies,  except 
where  a  margin  between  bankers'  buying  and  selling  rates 
for  cables  enters  in.  The  use  made  of  an  arbitrated  price 
is  to  compare  it  with  the  actual  domestic  price  to  tell 
whether  a  profitable  trade  in  the  article  is  possible.  In- 
cidental costs  of  effecting  the  trade  must  of  course  be 
considered. 

The  mint  par  or  mint  par  of  exchange  (for  definition 
and  explanations  see  §103  to  follow),  such  as  the  figure 
$4.8665  between  the  money  units  of   England   and  of  the 


402  FOREIGN  EXCHANGE 

United  States,  is  employed  in  many  conversions  of  values 
from  one  currency  to  another,  instead  of  the  rate  of  ex- 
change, where  the  purpose  of  the  conversion  is  merely 
statistical.  Customs  houses  may  also  commit  the  error  of 
using  the  mint  par.  The  mint  par  has  no  direct  bearing 
whatever  on  the  practical  undertakings  of  trade  and  com- 
merce. 

Not  only  the  price  of  a  security  in  a  foreign  country 
but  the  price  of  a  draft  or  cable  transfer  in  that  country 
on  a  third  country,  or  on  our  country  as  well,  may  be  the 
subject  matter  of  an  arbitrage  computation.  In  other 
words,  we  may  have  an  arbitrage  conversion  of  a  foreign 
quotation  of  exchange. 

To  illustrate, 

In      Amsterdam      telegraphic 

transfers  on  London  are  at.   12.10  florins  per  pound  sterling. 

In  New  York  the  cable  rate  on 

Amsterdam  is 40.2  cents  per  florin. 

The  New  York  Parity  op  a 
Pound  through  Amster- 
dam is 4.8642  dollars  per  pound. 

While  New  York's  actual  rate 
for  telegraphic  transfers  on 
London  might  be,  say 4.8645  dollars  per  pound. 

The  "parity"  of  $4.8642  is  derived  from  the  two  num- 
bers preceding  it.  So  far  as  mere  arithmetic  is  concerned, 
the  computation  takes  this  form : 

£1  =  12.10  florins. 
1  florin  =  .402  dollars. 
Therefore  £1  =  12.10  X  -402  or  4.8642  dollars. 

The  significance  of  the  figure  is  this:  it  shows  that  a 
pound  bought  through  Amsterdam  will  cost  the  New  York 


ARBITRAGE  403 

dealer  $4.8642,  and  equally  that  a  pound  sold  through 
Amsterdam  will  yield  a  New  York  dealer  $4.8642,  in- 
cidental charges  being  disregarded  in  both  cases.     Thus 

NEW  YORK  BANKER  SELLS  A  POUND  THROUGH 
AMSTERDAM 

He  has  a  pound  of  credit  in  London. 
His  agent  on  order  sells  a  cable  for  £1  in  Amsterdam. 
This  yields  a  credit  of  12.10  florins  in  Amsterdam. 
Banker  A  himself  sells  12.10  florins  of  cable  on  Amster- 
dam in  New  York  at  $.402  per  florin,  for $4.8642 

Again 

NEW  YORK  BANKER  BUYS  A  POUND  THROUGH 
AMSTERDAM 

He  buys  12.10  florins  of  cable  on  Amsterdam  which  at 

$.402  per  florin  cost $4.8642 

His  agent  in  Amsterdam  spends  the  12.10  florins  there 
for  £1  of  cable  on  London.  So  the  pound  has  cost 
$4.8642. 

For  every  pair  of  rates  (consisting  of  a  rate  in  Amster- 
dam on  London  and  a  rate  in  New  York  on  Amsterdam) 
there  is  a  given  parity.     For  a  few  examples: 


isterdam  on 

New  York  on 

London 

Amsterdam 

Parity 

12.10 

40.20 

4.8642 

12.10 

40.25 

4.8702 

12.10 

40.30 

4.8763 

12.11 

40.20 

4.8682 

12.11 

40.25 

4.8743 

12.11 

40.30 

4.8803 

The  arbitrager  provides  himself  with  extensive  tables 
for  ready  reference.  The  figure  known  as  the  "parity" 
is,  as  already  stated,  really  an  arbitrated  foreign  price  for 


KM  FOKKKJN   KX<  '1 1  AN(  IF 

some  kind  of  exchange.  Tts  chief  use  is  to  show  instantly 
what  possibilities  may  exist  for  an  arbitrage  operation.  If, 
for  instance,  the  actual  rate  for  a  pound  sterling  of  cable 
transfer  at  New  York  (say  4.8705)  is  higher  than  the 
parity  through  Amsterdam  (say  4.8702),  it  shows  that  a 
profit  can  be  gleaned  by  selling  cables  on  London  and 
covering  by  buying  cables  on  Amsterdam  and  repurchas- 
ing cables  on  London  in  Amsterdam.  If  the  actual  rate 
in  New  York  is  below  the  parity,  it  shows  that  a  profit 
can  be  made  by  buying  cables  on  London  in  New  York 
and  selling  cables  on  London  in  Amsterdam  and  selling 
cables  on  Amsterdam  in  New  York.  If  the  actual  rate  and 
the  parity  are  the  same,  no  profit  is  possible  from  an 
arbitrage  operation.  In  several  sections  to  follow,  the 
subject  of  arbitrage  and  indirect  remittance  will  be 
elaborated. 

§  96.  The  two  methods  of  direct  transfer  of  funds. — All 
arbitrage  manuals  seem  to  be  singularly  faulty  in  the  mat- 
ter of  exposition,  and  are  practically  useless  as  text-books. 
They  usually  employ  a  very  confused  terminology,  give  too 
few  definitions,  and  worthless  ones  at  that.  The  present 
chapter  of  this  book  takes  the  liberty  of  forming  its  own 
terminology  where  necessary. 

Funds  and  their  transfer. — Among  its  several  meanings 
the  word  fund  has  that  of  a  changing  or  moving  stock  of 
property  which  retains  a  given  ownership  or  control.  Ex- 
pressed, at  greater  length,  a  fund  in  this  sense  is  a  stock 
of  money  or  of  other  forms  of  property  for  which  money 
has  been  paid  and  which  are  convertible  back  into  money, 
a  stock  which  is  retained  in  a  constant  ownership  or  con- 
trol while  it  changes  its  form  or  location,  or  both.  Thus, 
I  might  have  a  sum  of  actual  money  in  New  York.  I 
might  deposit  it  with  a  bank,  draw  a  check  on  this  deposit 
and  pay  for  a  banker's  sight  draft  on  London,  exchange 
this  abroad  for  bank  credit,  use  this  bank  credit  to  buy 


ARBITRAGE  405 

Union  Pacific  stock  in  London,  ship  the  latter  back  to  New 
York  and  resell  it  there  in  the  stock  market  for  a  check 
on  a  local  bank  which  I  should  finally  deposit  in  the  first 
mentioned  bank.  There  has  been  a  stock  of  propertj^ 2 
throughout  these  dealings  that  has  been  mine  and  has 
been  under  my  control.  This  fund,  as  it  is  convenient  to 
call  it,  has  been  embodied,  so  to  say,  first  in  actual  money 
of  the  United  States,  second  in  bank  credit  in  New  York, 
third  in  a  sterling  bill  of  exchange,  fourth  in  a  deposit 
credit  in  a  London  bank,  fifth  in  a  certain  number  of 
shares  of  Union  Pacific  stock,  sixth  in  a  check  on 
some  New  York  bank,  seventh  and  finally  in  a  deposit 
credit  with  my  own  New  York  bank.  It  has  changed 
its  form  a  number  of  times  and  also  has  changed  its 
place.3 

A  transfer  of  funds  from  one  country  to  another  may 
be  effected 

(1)  by  an  export  of  merchandise  or  securities, 

(2)  by  an  export  of  actual  money4  or  of  gold 
bullion,  or 

(3)  by  means  of  a  pure  operation  in  exchange. 

Hereafter  in  this  chapter  we  have  to  do  with  transfers 
effected  in  the  latter  manner  alone.     A  transfer  of  funds 

2  Property,  not  in  the  popular  sense  of  land,  buildings,  or  tangible 
goods,  but  in  the  sense  which  includes  rights  of  action,  credits, 
bank  deposits,  etc.,  or  strictly  rights  against  persons  as  well  as 
in  things. 

8  The  fund  is  not  represented  to  be  a  physical  continuum.  It  is 
merely  something  we  choose  to  regard  as  a  persisting  identity 
for  convenience  of  thought  and  expression,  just  as  it  suits  us  in 
some  connections  to  think  of  a  chapter  of  a  lodge  or  fraternity  as  the 
same  chapter  now  as  at  the  time  of  its  foundation  although  all  the 
original  members  may  now  be  dead  and  gone. 

•*  If  the  exported  money  is  other  than  gold  and  is  sent  or 
carried  from  a  gold  standard  country,  it  will  ultimately  return 
home. 


406  FOREIGN  EXCHANGE 

between  two  places,  as  New  York  and  London,  is  direct 
if  it  involves  exchange  operations  only  in  New  York  and 
London.  It  is  indirect  if  it  involves  such  operations  in 
a  third  city,  as  Paris,  or  in  a  number  of  outside  cities, 
as  Paris  and  Amsterdam  both.  Direct  and  indirect  have 
then  a  geographical  significance  in  this  connection,  this 
being  a  matter  of  arbitrary  definition. 

A  direct  transfer  of  a  fund  may  be  accomplished  in 
two  ways.  (1)  The  party  who  transfers  may  remit  ex- 
change for  his  account  to  his  agent  or  partner  abroad. 
(2)  He  may  as  an  alternative  instruct  the  agent  to  draw 
upon  him  and  sell  the  exchange  so  drawn  in  the  foreign 
place  to  which  the  fund  is  to  be  transferred.  In  other 
words,  the  exporter  of  a  fund  may  produce  the  required 
result  either  by  remitting  exchange  or  by  submitting  to 
draft.  Either  method  brings  about,  first,  a  disappearance 
of  a  fund  at  home  (in  the  shape  of  money  or  credit  sur- 
rendered), and  second,  its  appearance  abroad  in  the 
changed  form  of  foreign  money  or  credit. 

Choice  between  the  two  methods  of  direct  transfer. — 
Where  each  of  the  two  centers  between  which  a  direct 
transfer  of  a  fund  is  to  take  place  possesses  a  free  and  ac- 
tive market  in  exchange  on  the  other,  both  methods  of 
transfer  are  feasible.  But  the  choice  between  them  is  not 
always  a  matter  of  indifference,  because  now  one  and  now 
the  other  may  have  the  advantage. 

We  take  the  liberty  even  in  this  year  of  writing  (1919) 
to  draw  our  next  illustration  from  dealings  between  Berlin 
and  Paris.  Suppose  a  banker  in  Berlin  has  occasion  to 
make  a  telegraphic  transfer  of  a  fund  of  100,000  marks 
from  his  city  to  Paris.  Should  he  buy  a  telegraphic 
transfer  (or  what  we  call  a  "cable"  when  it  crosses  the 
ocean)  on  Paris,  or  should  he  send  a  telegram  to  his  agent 
in  Paris  to  sell  exchange  for  marks  drawn  on  him?  As- 
sume the  following  rates: 


ARBITRAGE  407 

In  Berlin  telegraphic  transfers  on  Paris,  81.30  marks 
per  100  francs 

In  Paris  telegraphic  transfers  on  Berlin,  123.10  francs 
per  100  marks 

As  for  Paris  rate  for  sight  drafts  on  Berlin,  see  foot- 
note.5 

Try  the  two  methods. 

The  Purchase  of  a  T.  T.  on  Paris  in  Berlin 

100,000  marks  will  buy  at  the  rate  of  81.30,  and 

produce  in  Paris 123,001  francs 

(i.e.,  100,000 -=-81.30  =  123,001) 

The  Sale  of  a  T.  T.  on  Berlin  by  Paris  Agent 

100,000  marks  sold  at  rate  of  123.10  fetch  in  Paris  123,100  francs 
(i.e.,  100,000  X  123.10  =  123,100) 

With  the  data  here  given  the  second  method  is  prefer- 
able as  yielding  99  francs  more  than  the  first.  The  differ- 
ence between  the  two  is  exaggerated  compared  with  what 
could  be  expected  in  practice  in  times  of  free  intercourse. 
What  we  have  above  is  a  mere  illustration.  The  data 
might  be  so  changed  as  to  make  the  first  the  more  pro- 
ductive method,  or  again  to  make  the  two  equivalent. 
They  would  be  equivalent,  for  instance,  if  Berlin  on  Paris 
were  at  81.30  and  Paris  on  Berlin  at  123,  or,  again,  if 
the  pair  of  rates  were  81.16  and  12)5.20.  The  members  of 
a  pair  of  rates  in  such  a  position  are  said  to  be  "at  a 
parity"  with  each  other.  It  is  an  economic  law  that  the 
two  members  of  such  a  pair  tend  to  maintain  positions  of 
parity  under  all  conditions  of  commerce  day  in  and  day 

■>  The  transfer  of  the  fund  tit  Paris  is  equally  quick  whether  Paris 
sells  telegraphic  transfers  or  sight  drafts  on  Berlin,  but  if  the 
latter  are  sold  the  Berlin  banker  has  a  day  or  two  before  being 
required  to  disburse  marks  and  receives  slightly  less  francs  at  Paris 
owing  to  the  lower  selling  price  of  sight  drafts.  1'or  the  sake  of 
simplicity  we  omit  to  consider  the  case  separately. 


408  FOREIGN  EXCHANGE 

out.  It  must  bo  hold  in  mind  thorp  are  an  indefinite  num- 
ber of  such  positions  of  parity  much  as  there  are  an  in- 
definite number  of  positions  of  a  see-saw  across  a  log  in 
which  the  board  may  remain  unbent  or  unbroken.6 

§  97.  Two-point  arbitrage. — Two-point  arbitrage  is  ar- 
bitrage which  embraces  transactions  in  exchange  at  two 
geographical  points,  and  two  only.  Otherwise  described, 
it  is  an  operation  in  which  a  fund  is  sent  from  a  first  place 
to  a  second  and  then  directly  back  to  the  first,  both  trans- 
fers being  accomplished  by  dealings  in  exchange.  It  is 
arbitrage,  as  distinguished  from  a  mere  transfer  of  funds, 
in  that  it  involves  a  return  of  the  fund  to  the  point  of 
origin,  or  a  swing  round  the  circle. 

In  arbitrage  an  operator  may  deal  in  telegraphic  trans- 
fers, sight  drafts,  long  bills,7  and  exchange  for  future  de- 
livery, but  our  attention  will  be  directed  at  present  chiefly 
to  arbitrage  in  telegraphic  transfers.  Setting  aside  any 
classification  based  on  the  different  terms  of  life  of  the 
exchange  employed,  there  are  two,  and  only  two,  cases 
of  the  two-point  arbitrage  operation.  These  are  the  two 
fundamental  cases.  They  would  be  found  if  there  were 
exchange  of  only  one  term  of  life  known  throughout  the 
world.     It  is  understood  there  must  be  a  dealer  in  exchange 

e  In  the  case  where  we  compare  the  rate  in  a  first  city  upon  a 
second,  with  the  rate  in  the  second  on  the  first,  if  we  have  one 
rate  given  us  as  123  francs  in  Paris  for  100  marks*  of  Berlin  tele- 
graphic transfers,  we  calculate  the  parity  point  of  the  other  rate 
simply  hy  dividing  the  123  into  100.  Thus  100  -j-  123  =  .8130.  If 
123  francs  equal  100  marks,  then  at  the  same  ratio  81.30  marks 
equal  100  francs.  This  holds  good  if  both  rates  are  quoted  "di- 
rectly" or  both  are  quoted  "indirectly"  ( compare  §  22 ) .  But  if  one 
is  quoted  "directly"  and  the  other  "indirectly,"  the  rates  are  at 
parity  when  they  are  exactly  the  same.  Thus  when  sterling  is 
quoted  in  Paris  at  25.15,  exchange  on  Paris  in  London  (quoted 
"indirectly")   is  at  parity  when  at  the  same  figure,  25.15. 

t  That  is,  it  is  possible  for  the  purchase  of  long  bills  to  become 
a  part  of  an  arbitrage  operation. 


ARBITRAGE  409 

at  each  of  the  two  geographical  points,  and  these  dealers 
must  cooperate,  whether  in  a  relation  of  partnership  or  of 
agency.  Described  as  briefly  as  possible,  the  two  cases  of 
the  operation  are : 

I.  Each  dealer  draws  on  the  other. 
II.  Each  dealer  buys  exchange  to  remit  to  the  other. 

Case  I  is  that  of  mutual  submission  to  draft,  or  that  in 
which  each  dealer  sells  exchange  on  the  other.  There  are 
two  reciprocal  sales.  Case  II  is  that  of  an  interchange  of 
remittances,  or  that  in  which  each  dealer  buys  exchange 
in  his  city  to  be  sent  to  the  other.  There  are  two  reciprocal 
purchases.  Which  of  the  two  cases  transpires  or  material- 
izes at  any  time  depends  upon  the  direction  in  which  the 
rates  of  exchange  in  the  two  cities  (each  on  the  other) 
break  from  parity. 

If  required  to  show  that  these  two  cases  exhaust  the 
possibilities  of  two-point  arbitrage,  we  should  proceed  as 
follows  (it  being  understood  that  in  looking  for  funda- 
mental cases  we  agree  to  ignore  different  kinds  of  exchange 
classified  according  to  term  of  life,  and  to  treat  of  ar- 
bitrage that  can  be  accomplished  in  one  kind  alone,  as  say 
in  telegraphic  transfers).  The  arbitrager  at  each  point 
can  only  buy  or  sell  exchange  on  the  other  point.8  The 
arbitrage  must  consist  in  a  pair  of  transactions  in  ex- 
change, one  undertaken  by  each  dealer.  There  are  four 
possible  transactions  from  which  this  pair  can  be  selected. 
These  are 

1.  Dealer  A  sells  exchange  drawn  on  dealer  B 

2.  Dealer  A  buys  exchange  in  the  market  to  remit  to 

dealer  B 

3.  Dealer  B  sells  exchange  drawn  on  dealer  A 

s  If  dealings  in  exclinii^r  ,n  n  third  point  arc  introduced  t lie;  case 
is  no  longer  one  of  two-point  arbitrage. 


4K»  FOREIGN  EXCHANGE 

4.  Dealer   B  buys  exchange  in  the  market  to  remit  to 
dealer  A 

From  these  four  separate  transactions,  four  pairs  can  be 
formed,  namely, 

1.  A  sells  and  B  sells 

2.  A  sells  and  B  buys 

3.  A  buys  and  B  sells 

4.  A  buys  and  B  buys 

Or,  there  are  three  pairs  if  we  do  not  distinguish  between 
the  two  dealers,  namely: 

1.  Both   sell    (No.   1  abovM 

2.  One  sells  and  the  other  buys  (Nos.  2  and  3  above) 

3.  Both  buy  (No.  4  above) 

In  the  case  where  one  sells  and  the  other  buys  (No.  2  just 
above)  there  can  be  no  arbitrage,  for  the  result  can  only 
be  a  pair  of  transfers  of  funds  or  credits,  both  in  the  same 
direction,  or  a  double  transfer  of  funds.  To  illustrate:  if 
A  sells  and  B  buys  exchange,  A's  transaction  will  put  A 
in  funds  at  B's  expense,  and  B's  transaction  will  also  put 
A  in  funds  at  B's  expense.  A  draws  on  B  and  sells  the 
draft,  and  B  buys  exchange  to  remit  to  A !  This  is  clearly 
not  arbitrage  (cf.  definitions,  page  400).  In  truth,  such 
a  pair  of  transactions  has  no  reason  for  being.  As  the 
saying  goes,  it  does  not  make  good  sense.  If  it  is  desired 
to  transfer  a  fund  from  B  to  A,  to  pay  a  debt,  or  for  some 
other  purpose,  it  would  naturally  be  effected  by  A's  draw- 
ing or  by  B's  remitting,  according  to  which  method  was 
best  (see  §  96)  but  not  by  a  mixture  of  the  two. 

In  the  cases  (a)  where  each  arbitrager  draws  on  the 
other,  and  where  consequently  each  sells  exchange  in  his 
own  city,  and  (b)  where  each  remits  to  the  other  and  con- 
sequently each  buys  exchange  in  his  own  city,  there  are 
two  opposite  or  reciprocal  transfers  of  funds.     There  is 


ARBITRAGE  411 

no  motive  for  these  operations  except  to  reap  an  in- 
cidental profit  made  available  by  the  relative  position  of 
the  rates  of  exchange.  Each  of  them  is  an  arbitrage,  and 
they  constitute  the  only  two  that  are  possible. 

It  was  stated  that  whether  (a)  or  (b)  above  is  to  be 
adopted  depends  on  the  direction  of  the  departure  or  break 
of  the  rates  of  exchange  from  the  position  of  parity. 
Curiously,  a  pair  of  rates  can  break  from  parity  in  only 
two  ways:  (1)  both  may  become  too  high,  or  (2)  both 
may  become  too  low,  each  with  reference  to  the  other. 
This  beyond  doubt  needs  explanation. 

A  position  of  parity,  it  must  be  kept  in  mind,  does  not 
mean  a  position  at  the  mint  par.  The  mint  par  has  no 
immediate  bearing  on  the  present  problem.  To  be  in  a 
position  of  parity  the  two  exchange  rates  must  simply  show 
the  same  value-ratio  between  the  two  national  currency 
units. 

Introducing  Paris  and  Berlin  with  their  francs  and 
marks  into  an  illustration  once  again,  assume  the  follow- 
ing rates  for  telegraphic  transfers: 

A 

RATES  OF  EXCHANGE 

In  Paris  In  Berlin 

123  francs  per  100  marks  81.30  marks  per  100  francs 

These  rates  are  in  a  position  of  parity,  for  the  Paris  rate 
and  the  Berlin  rate  show  the  same  value-ratio  between 
francs  and  marks.     Thus, 

V alue-Iiatio  expressed  in  francs  per  murk 

According  to  Paris  quotation 1.23  francs  =  1  mark 

According  to  Berlin  quotation 
81.30  marks  =  100  francs 

1  mark  =  %i.s  ol    LOO  francs 

=  1.23  francs,  or....   1.23  francs  =  1  mark 
At  these  rates  no  profit  is  possible  from  arbitrage. 


412  FOREIGN  EXCHANGE 

Next  assume  the  following : 

B 

RATES  OF  EXCHANGE 

In  Paris  In  Berlin 

123  francs  per  100  marks  81.40  marks  per  100  francs 

The  rates  are  no  longer  in  a  position  of  parity,  this  be- 
cause they  show  different  value-ratios.     Thus : 

Value-Ratio  expressed  in  francs  per  mark 

According  to  Paris  quotation 1.23  francs  =  1  mark 

According  to  Berlin  quotation 
81.40  marks  =  100  francs 

1  mark   =  Vsia  of  100  francs 

=  1.2285  francs,  or  1.2285  francs  =  1  mark 

Value-Ratio  expressed  in  marks  per  franc 
According  to  Paris  quotation 
123  francs  =  100  marks 
1  franc   =  10%23  marks 

=  .813  marks,  or 813  marks  =  1  franc 

According  to  Berlin  quotation 814  marks  =  1  franc 

Under   this   misadjustment,    francs    have    a   higher   value 
in  the  Berlin  ratio  than  in  the  Paris  ratio.     Thus: 

According  to  Berlin  1  franc  =  .814  marks 

According  to  Paris 1  franc  =  .813  marks 

But  marks  have  a  higher  value  in  the  Paris  ratio  than  in 
the  Berlin  ratio;   Thus: 

According  to  Paris 1  mark  =  1.23       francs 

According  to  Berlin 1  mark  =  1.2285  francs 

Francs  are  above  parity  in  Berlin  9  and  marks  are  above 
parity  in  Paris.     Under  the  circumstances,  which  of  the 

s  Signifying  only   that   francs   are   valued   more   highly   in   Berlin 
than   in  the  Paris  ratio. 


ARBITRAGE  413 

two  possible  two-point  arbitrage  operations  are  the  dealers 
to  select?  Obviously  that  of  reciprocal  sales  of  exchange. 
Each  should  sell  a  telegraphic  transfer  on  the  other,  the 
Parisian  selling  marks  in  Paris  where  they  are  higher,  and 
the  Berliner  selling  francs  in  Berlin  where  francs  are 
higher. 

Suppose  the  Parisian  acts  as  principal.  He  sells  a  tele- 
graphic transfer  for  perhaps  100,000  marks.  The  Ber- 
liner then  should  sell  a  telegraphic  transfer  for  a  sufficient 
number  of  francs  to  bring  in  100,000  marks.  Below  is  an 
account  of  the  operation. 

Transactions 

100,000  marks  sold  in  Paris  at  123,  fetch 123,000  francs 

122,850  francs  sold  in  Berlin  at  81.40,  fetch. .  100,000  marks 
(122,850  X  81.4  =  100,000) 10 

Profit 

AT   BERLIN 

Received  from  sale  of  telegraphic  transfer 

drawn  on  Paris 100,000  marks 

Disbursed     to     pay     telegraphic     transfer 

drawn  in  Paris 100,000  marks 

Profit    none. 

AT  PARIS 

Received  from  sale  of  telegraphic  transfer 

drawn  on  Berlin 123,000  francs 

Disbursed     to     pay.    telegraphic     transfer 

drawn  in  Berlin  122,850  francs 

Profit    150  francs 

Now  we  assume  the  third  position  of  the  two  rates  of 
exchange. 

io  Exactly,    122,850  X  81.4  =  99,999.90   marks. 


414  FOREIGN  EXCHANGE 

C 

RATES  OF  EXCHANGE 

In  Paris  In  Berlin 

123  francs  per  100  marks  81.20  marks  per  100  francs 

These  rates  also  deviate  from  parity.     Thus: 

Value-Ratio  expressed  in  francs  per  mark 
According  to  Paris  quotation ....  1.23       francs  =  1  mark 
According  to  Berlin  quotation 
81.20  marks  =  100  francs 
1  franc   =  109i23  marks 

=  1.23153  f cs.,  or  1.23153  francs  =  1  mark 

Value-Ratio  expressed  in  m-arks  per  franc 
According  to  Paris  quotation 
123  francs  =  100  marks 
1  mark    =  10/8i.2  francs 

=  .813  marks,  or 813  marks  =  1  franc 

According  to  Berlin  quotation 812  marks  =  1  franc 

Under  this  misadjustment  the  foreign  unit  is  too  low  in 
each  of  the  two  cities  as  compared  with  its  position  in  the 
other.  Francs  have  a  lower  value  in  the  Berlin  than  in 
the  Paris  ratio.     Thus: 

According  to  Berlin   1  franc  =  .812  marks 

According  to  Paris 1  franc  =  .813  marks 

But  marks  have  a  lower  value  in  the  Paris  ratio  than  in 
the  Berlin  ratio.     Thus: 

According  to  Paris 1  mark  =  1.23         francs 

According  to  Berlin 1  mark  =  1.23153  francs 

Consequently  the  indicated  operation  is  that  of  re- 
ciprocal purchase  and  remittance,  an  account  of  which 
follows : 


ARBITRAGE  415 

Transaction 

100,000  marks  bought  at  Paris  at  123,  cost.  . .   123,000  francs 
123,153  francs  bought  at  Berlin  at  81.20,  cost.   100,000  marks 
(123,153  X  -812  =  100,000) 

Profit 

AT   BERLIN 

Received,  remitted  from  Paris  on  tele- 
graphic order    100,000  marks 

Disbursed,  for  telegraphic  transfer  to  Paris  100,000  marks 

Profit    none. 

AT  PARIS 

Received,  remitted  from  Berlin  on  tele- 
graphic order   123,153  francs 

Disbursed,    for    telegraphic     transfer     on 

Berlin   123,000  francs 

Profit    153  francs 

To  summarize :  there  are  two  directions  only  in  which 
a  pair  of  exchange  rates  may  diverge  or  break  from 
parity,  and  there  are  two  fundamental  cases  or  classes 
of  the  two-point  arbitrage  operation,  and  two  only.  The 
very  taking  of  the  arbitrage  profit  which  a  break  from 
parity  makes  possible  tends  to  restore  the  parity.  Also 
the  constant  selection  by  dealers  of  the  better  of  the  two 
methods  of  transferring  funds  between  any  two  exchange 
centers  exerts  exactly  the  same  influence  upon  the  mutual 
rates.  Since  such  transfers  are  always  being  effected,  the 
choice  between  methods  has  a  very  powerful  tendency  to 
keep  rates  in  the  position  of  parity,11   and  this  effeel    re- 

ii  To  determine  that  two  mutual  rates  must  stand  at  parity  does 
not  in  the  least  mean  to  determine  the  position  of  the  pair  of 
rates.  There  is  an  indefinite  number  <>f  different  positions  of  parity 
for  a  pair  of  rates  just  as  there  is  an  indefinite  number  of  positions 
of  the  see-saw  obtainable  withoul   bending  or  breaking  the  hoard. 


416  FOREIGN  EXCHANGE 

duces  greatly  the  opportunity  for  profitable  two-point 
arbitrage  transactions.  The  continual  choosing  of  the  best 
means  of  transferring  funds  has  the  effect  in  great  de- 
gree of  forestalling  arbitrage. 

§  98.  Methods  of  indirect  transfer  of  funds. — An  indirect 
transfer  of  funds  by  means  of  exchange  is  one  which  in- 
volves an  exchange  transaction  in  another  city,  or  a  trans- 
action in  exchange  on  another  city,  than  the  two  between 
which  the  fund  is  transferred.  The  transfer  is  indirect 
in  a  geographical  sense,  in  the  sense  that  the  migrating 
fund  pursues  a  circuitous  course  geographically.  For 
example,  a  fund  may  be  sent  from  New  York  to  London 
through  Paris.  The  arbitrage  operation  considered  at  the 
opening  of  this  chapter  involved  as  one  of  its  parts  this 
exact  indirect  transfer.  (Any  three-point  arbitrage  will 
contain  as  a  component  some  such  indirect  transfer.) 

Telegraphic  transfers  alone  being  employed,  there  are 
just  four  distinct  methods  of  transferring  a  fund  from  a 
first  center  to  a  second  through  a  third.  There  are,  there- 
fore, what  we  would  call  the  four  "fundamental  cases" 
of  the  operation.  If  a  New  York  banker  is  to  transfer  a 
fund  to  London  through  Paris,  the  four  cases  are : 

1.  The  New  York  banker  buys  a  cable  on  Paris  and  directs  his 
Parisian  correspondent  to  buy  a  telegraphic  transfer  on  London. 

(Net  result:  Banker's  dollars  disappear  in  New  York  and 
pounds  emerge  in  London.) 

2.  The  New  York  banker  buys  a  cable  on  Paris,  but  directs  his 
London  correspondent  to  sell  a  telegraphic  transfer  on  Paris 
against  this  as  cover. 

(Net  result:  the  same  as  before.) 

3.  The  New  York  banker  directs  his  Parisian  correspondent  to 
sell  a  cable  on  New  York,  and  employ  proceeds  of  this  sale  to  buy 
a  telegraphic  transfer  on  London. 

(Net  result:  the  same  as  before.) 


ARBITRAGE  417 

4.  As  in  3,  Paris  draws,  but  against  the  franc  credit  thus  cre- 
ated, London  sells  a  telegraphic  transfer  on  Paris. 

(Net  result:  the  same  as  before.) 
More  briefly,  the  four  operations  are: 

1.  New  York  buys  francs :  Paris  buys  pounds  sterling. 

2.  New  York  buys  francs:  London  sells  francs. 

3.  Paris  sells  dollars:  Paris  buys  pounds  sterling. 

4.  Paris  sells  dollars :  London  sells  francs. 

The  total  result  in  all  cases  is  a  transfer  of  a  fund  or 
credit  from  New  York  to  London.  The  Paris  correspond- 
ent is  neither  "in"  nor  "out"  funds  as  a  consequence  of 
this  operation. 

The  choice  among  the  four  possible  methods  depends 
upon  the  positions  of  the  rates  of  exchange  that  govern 
the  individual  transactions  which  may  serve  as  components 
to  make  up  the  whole  transfer.  It  would  lengthen  our 
discussion  inordinately  to  work  out  a  set  of  practical  illus- 
trations in  connection  with  this  problem. 

The  four  methods  are  the  theoretical  four  fundamental 
cases.  In  practice  all  four  would  be  developed  only  un- 
der conditions  where  each  of  the  three  cities  had  an  ac- 
tive market  in  bills  and  telegraphic  transfer  on  each  of 
the  other  two.  The  same  four  are  possible  with  sight 
drafts  employed  throughout,  instead  of  telegraphic  trans- 
fers. But  where  these  instruments  are  used,  there  must, 
in  most  instances,  be  either  a  greater  speculation  on  the 
position  of  certain  rates,  owing  to  the  lapse  of  time  dur- 
ing which  a  bill  is  in  the  mail,  or  there  must  be  contracts 
for  the  forward  or  future  sale  or  purchase  of  sight  ex- 
change (c/.  §  100  herein). 

If  a  bill  (or  actual  negotiable  instrument)  is  the  Conn 
of  exchange  employed  in  the  indirecl  transfer,  a  question 
arises  as  to  whether  there   is  not   a  fit'tli   case,   or  a  case 


418  FOREIGN  EXCHANGE 

distinct  from  the  four  already  set  forth.  Suppose  the 
banker  buys  a  cheek  on  Paris  and  mails  it  to  London,  where 
he  sells  it  for  sterling,  it  being  willingly  taken  in  London  as 
good  exchange  on  Paris.  Clearly  there  has  been  a  trans- 
fer of  a  fund  from  New''  York  to  London,  but  has  this 
transfer  been  direct  or  indirect,  and,  if  the  latter,  is  it  a 
fifth  case?  The  answer,  in  our  view,  is  that  the  transfer 
is  indirect  (compare  the  definition  at  the  beginning  of 
this  section),  but  that  it  is  a  disguised  form  of  the  second 
case,  namely,  the  one  in  which  New  York  buys  francs  and 
London  sells  francs.12 

§  99.  Three-point  and  more  complex  arbitrage. — Three- 
point  arbitrage,  or  arbitrage  embracing  transactions  in 
exchange  in  or  on  three  geographical  points,  may  be 
analyzed  into  the  two  components  of  (1)  a  direct  transfer 
of  a  fund  from  the  point  where  the  operator  stands  to 
another  point,  and  (2)  an  indirect  transfer  thence  through 
a  third  point  back  to  the  point  of  origin.  We  have  now 
reached  the  puzzle  department  of  foreign  exchange.  There 
are  sixteen  theoretically  distinct  ways  of  performing  a 
three-point  arbitrage  operation  with  one  kind  of  exchange 
(as  telegraphic  transfer)  used  throughout,  that  is,  there 
are  what  we  would  call  sixteen  fundamental  cases  of  the 
operation.  Six  different  rates  of  exchange  come  under 
consideration  in  the  planning  of  such  an  operation   (un- 

12  In  Tate's  "Modern  Cambist,"  24th  edition,  London,  1908,  p. 
275,  such  operations  are  mentioned  as  the  purchase  by  a  London 
dealer  of  a  long  bill  drawn  in  London  on  Amsterdam,  and  the  re- 
sale of  this  bill  in  Paris,  instead  of  its  discount  in  Amsterdam. 
We  should  be  compelled  to  define  this  as  indirect  transfer,  case  2. 

One  part  of  an  indirect  transfer  may  consist  of  a  gold  shipment. 
For  example,  London  may  transfer  a  fund  to  New  York  by  an 
operation  in  exchange,  and  have  an  agent  in  the  latter  city  convert  it 
into  gold  to  be  shipped  to  Buenos  Aires.  This  actual  operation  has 
been  mentioned  a  number  of  times  in  past  years  in  our  financial 
iournals. 


ARBITRAGE  419 

less  some  of  these  rates  are  omitted  for  lack  of  being  the 
expression  of  real  or  active  markets  in  exchange).  Each 
of  the  three  cities  may  have  a  rate  on  each  of  the  other 
two,  there  being  thus  two  rates  in  each  city  and  six  in  all. 

Let  us  first  search  out  the  sixteen  cases.  As  shown  in 
§  98,  there  are  four  ways  of  transferring  a  fund  or  credit 
from  one  city  to  a  second  through  a  third ;  and,  as  shown 
in  §  96,  there  are  two  ways  of  making  what  we  have  called 
a  direct  transfer.  Thus  New  York  can  transfer  a  fund 
to  London  through  Paris  in  four  ways.  It  can  then  re- 
transfer  directly  from  London  to  New  York  in  two  ways. 
Each  of  the  latter  two  can  be  combined  with  each  of  the 
preceding  four.  This  makes  eight  distinct  methods  where- 
by New  York  can  send  a  fund  through  Paris  to  London 
and  thence  to  New  York  again.  There  are  also  eight  other 
distinct  methods  whereby  New  York  can  send  a  fund 
through  London  to  Paris  and  thence  to  New  York.  This 
makes  a  total  of  sixteen  combinations  of  transactions  in 
exchange. 

The  following  table  sets  them  forth  in  detail. 

THE  16  ARBITRAGE  OPERATIONS  WHICH  NEW  YORK 

CAN     EFFECT     THROUGH     LONDON    AND     PARIS, 

EMPLOYING   A   SINGLE   KIND    OF   EXCHANGE 

THROUGHOUT,  AS  CABLES 

First  group  of  8,  involving  an  indirect  transfer  to  London. 

(1)  N.   Y.   remits   to  Paris:  Paris   remits   to   London:  London    remits    to   N.    Y. 

(2)  (Same)  :  N.   Y.   draws   on   London. 

(3)  N.   Y.    remits    to    Paris:  London   draws   on    Paris:  London    remits    to    N.    V. 

(4)  (Same)  :  N.    Y.   draws   on   London. 

(5)  Paris  draws  on  N.  Y.:  Paris  remits  to  London:  London  remits  to  N.  Y. 
(fi)  (Same)  :  N.   Y.   draws   on   London. 

(7)  Paris   draws   on   N.   Y.:  London    draws   on   Paris:  London    remitB    to    N.    Y. 

(8)  (Same)  :  N.   Y .   draws  on  London. 

Second  group  of  8,  involving  an  indirect  transfer  to  Paris. 

(1)  N.  Y.  remits  to  London:  London    remits    to    Paris:  Paris     remits     to     N.     Y 

(2)  (Same)  :  N.    Y.    draws    on    Paris. 

(3)  N.  Y.  remits  to  London:   Paris    draws   on    London:   Paris     remits     to     N.     Y. 

(4)  (Same)  :  N.     Y.    draws    on     Paris. 


420  FOREIGN  EXCHANGE 

(5)  London  draws  on  N.  Y.:  London    remits   to   Paris:  Paris     remits    to    N.     Y. 

(6)  (Same)  :  N.    Y.    draws    on    Paris. 

(7)  London  draws  on  N.  Y.:  Paris  draws  on  London:  Paris    remits    to    N.     Y. 

(8)  (Same)  :  N.    Y.    draws    on    Paris. 

Among  these  cases  there  are  no  duplicates.  Likewise, 
there  are  no  possible  cases  not  included  in  the  sixteen. 
The  arbitrage  may  be  engineered  from  Paris  or  London 
as  well  as  from  New  York,  but  there  are  not  three  times 
sixteen  cases. 

The  example  of  three-point  arbitrage  placed  at  the  head 
of  the  present  chapter  comes  under  method  2  of  group  1 
in  the  above  table.  To  give  additional  examples,  let  us 
first  take  an  illustration  of  method  5  of  group  1 :  Let  the 
arbitrager  operate  with  $10,000.  (1)  The  first  step  is 
taken  by  New  York's  directing  Paris  to  sell  $10,000  of 
telegraphic  transfer  upon  New  York.  Assuming  the  rate 
to  be  520  (that  is,  520  francs  for  each  $100  of  cables)  the 
result  is  a  fund  of  52,000  in  Paris.  (2)  For  the  second 
step,  New  York  directs  Paris  to  purchase  a  cable  on  Lon- 
don, the  rate  for  the  latter  being,  say,  25.20  francs  per 
pound.  As  a  consequence,  Paris  obtains  £2,063.05,  ap- 
proximately, of  sterling  cables  (i.e.,  52,000-^-25.20).  Lon- 
don is  next  directed  to  spend  this  £2,063.05  for  a  cable 
transfer  on  New  York  at  the  existing  rate,  which  we  shall 
suppose  to  be  quoted  after  the  London  fashion,  491/4d.  per 
dollar. 

£2,063.05=  (at  240d.  per  £)  495,240d. 

495,240d.  will  buy  $10,055.60  cables  at  49%d.  per  dollar. 

For  an  outlay  of  $10,000  the  New  York  operator  receives 
back  $10,055.60,  and  thus  obtains  a  gross  profit  of  $55.60. 
For  another  example,  take  method  4  of  group  2  and 
operate  with  $10,000  as  above.  (1)  New  York  buys  $10,- 
000  worth  of  cables  on  London  at  say  4.85,  obtaining 
£2,061.85.  (2)  Paris  is  then  directed  to  sell  £2,061.85  of 
cables  on  London  at  the  existing  Parisian  rate  for  this 


ARBITRAGE  421 

exchange,  say  25.25.  This  yields  a  proceeds  in  francs 
of  52,061.70.  (3)  New  York  sells  a  cable  for  52,061.70 
francs  at,  say,  5.17/£.  This  signifies  that  New  York  ob- 
tains $1  for  every  5.17^  francs  of  this  cable  transfer,  or 
$10,060.20  for  the  whole.  The  gross  profit  then  in  this 
instance  is  $60.20. 

The  rates  assumed  in  the  foregoing  examples  were  chosen 
arbitrarily,  and  are  not  designated  to  show  anything  as 
to  the  actual  percentage  of  profits  ordinarily  procurable 
in  arbitrage  under  competition.  If  the  six  rates  in  the 
three  cities  implicated  in  a  three-point  arbitrage  are  in 
perfect  adjustment — that  is,  in  that  adjustment  which 
arbitrage  itself  tends  to  produce — none  of  the  sixteen  op- 
erations could  be  conducted  at  a  profit.  Misadjustments, 
or  departure  from  parity,  will  make  some  operations  show 
a  profit,  while  others,  if  undertaken,  would  show  a 
loss. 

In  the  case  of  arbitrage  with  bills  (whether  sight  or  long) 
as  contrasted  with  cables,  there  will  be  a  more  appreciable 
lapse  of  time  between  outlay  and  return  (though  a  dis- 
countable long  bill  is  not  so  much  slower,  as  a  remittance, 
than  a  sight  draft).  Assuming  sight  bills  to  be  used 
throughout,  the  length  of  time  required  for  the  arbitrage 
operation  differs  very  greatly,  according  to  which  of  the 
sixteen  theoretical  cases  we  suppose  to  be  chosen.13 

Four-point  arbitrage. — In  three-point  arbitrage  a  fund 
or  credit  travels  around  a  triangle,  making  a  journey  in 
one  direction  between  each  two  of  the  three  cities. 
Thus: 

it  If  the  purchase  in  New  York  of  ;i  si<;lit  bill  on  Paris,  its  remit- 
tance to  London  for  sale  there,  and  the  drawing  <>f  a  sight  bill  on 
London  against  this  as  cover,  ought  to  be  counted  as  one  of  the 
theoretical  cases  of  throe-point  arbitrage,  it  might  be  argued  that 
there  are  more  than  sixteen  cases  with  sight  bills.  Bui  again,  we 
might  assimilate  this  with  the  case  (I)  New  York  remits  to  I'aris; 
(2)   London  draws  on  Paris;   (3)  New  York  draws  on  Ixmdon. 


42a  FOREIGN  EXCHANGE 

§  P 


Now  it  is  always  possible  that  rates  in  or  on  the  fourth 
city,  D,  should  reach  such  an  adjustment  that  the  transfer 
from  B  to  C  might  better  take  place  through  D.  This 
new  indirect  transfer,  which  it  might  become  profitable 
to  engraft  upon  the  three-point  arbitrage,  is  in  and  of 
itself  as  simple  as  the  operation  discussed  in  §  98,  but 
it  converts  the  three-point  into  the  practically  more  com- 
plex four-point  arbitrage,  represented  in  this  manner. 


Four-point  arbitrage  presents  no  new  questions  of  principle. 
There  are  96  fundamental  cases  (or  combinations)  ob- 
tainable with  telegraphic  transfers  alone  employed  through- 
out. In  practice,  complex  forms  of  arbitrage  are  over- 
weighted with  expense,  and  probably  are  comparatively 
rare.  The  continual  flow  of  arbitrages  of  a  simpler  char- 
acter tends  to  forestall  the  more  complex.  For  illustration, 
three-point  arbitrage  involving  B,  C,  and  D,  and  three- 
point  arbitrage  involving  A,  B,  and  C,  etc.,  tend  to  fore- 
stall any  four-point  undertaking.  Compare  the  tendency  to 
choose  the  cheapest  method  of  a  mere  transfer  of  funds  to 
forestall  even  the  simpler  arbitrage  operations. 


ARBITRAGE  423 

Arbitrage  distinguished  from  other  exchange  operations 
involving  simultaneous  outlay  and  return. — The  purchase 
of  long  bills  on  a  given  country  and  the  simultaneous  sale 
of  sight  drafts  against  these  upon  the  same  country  is  a 
transaction  which  in  some  respects  resembles  arbitrage,  but 
which  is  not  arbitrage.  In  this  transaction  there  are  pres- 
ent the  purchase  of  one  kind  and  the  sale  of  another  kind 
of  exchange  as  parts  of  a  larger  single  operation  for  a 
profit.  But,  if  an  operation  is  to  constitute  what  is  known 
as  arbitrage,  the  different  kinds  of  exchange  dealt  in  must 
be  different  in  nationality,  if  we  may  so  express  it.  Two 
pieces  of  exchange  differ  in  nationality,  either  if  they  are 
drawn  upon  different  countries,  or  if  they  are  drawn  in 
different  countries.  A  New  York  bill  drawn  on  Paris  has 
a  different  nationality  for  the  purposes  of  our  definition, 
from  a  New  York  bill  drawn  on  London.  Also,  a  Paris 
draft  on  London  has  a  different  nationality  for  the  pur- 
poses of  our  definition  from  a  New  York  draft  on  London. 
Arbitrage  as  an  exchange  operation,  distinguished  from 
all  others,  is  one  which  involves  the  sale  and  purchase, 
as  nearly  simultaneously  as  possible,  of  pieces  of  exchange 
of  different  nationalities,  and  which  involves  a  return  of 
the  fund  employed  to  the  point  in  which  the  original  outlay 
was  made. 

§  100.  Arbitrage,  speculation,  and  futures. — We  can  easily 
conceive  of  an  arbitrage  in  which  there  is  not  the  smallest 
element  of  speculation,  and  doubtless  operations  of  this 
character  are  carried  out  in  great  number.  Thus,  if  banker 
X  whips  a  fund  around  the  triangle  formed  by  New  York, 
Paris,  and  London,  by  making  a  purchase  in  New  York 
of  cables  on  Paris,  and  making  a  purchase  in  Paris  of 
telegraphic  transfers  on  London,  and  making  a  sale  in  New 
York  of  sterling  cables,  it  is  entirely  possible  thai  lie  should 
have  all  the  transactions  constituting  the  arbitrage  defi- 
nitely arranged  by  cable  before  giving  any  orders  to  for- 


124  FOREIGN  EXCHANGE 

eign  agents,  or  taking  any  steps  of  his  own.  "We  might 
caU  such  an  operation  (one  free  from  the  slightest  admix- 
ture of  speculation)   a  "pure"  arbitrage. 

The  following  wholly  supposititious  example  shows  an 
arbitrage  which  by  way  of  contrast  would  involve  a  con- 
siderable degree  of  speculation.  Thus,  suppose  X  acting 
on  the  basis  of  the  sight  rates  quoted  in  the  three  places 
at  the  moment  of  his  decision,  buys  sight  bills  on  Paris 
and  mails  them  with  instructions  that  their  yield  in  francs 
be  spent  upon  arrival  for  sight  sterling  bills,  these  to  be 
forwarded  to  London  for  X's  credit.  After  waiting  two 
or  three  days  to  avoid  overdraft,  X  completes  the  arbi- 
trage by  making  a  sale  in  New  York  of  demand  drafts  on 
London.  Taking  the  case  exactly  as  stated,  and  not  con- 
cerning ourselves  with  the  question  whether  a  dealer  would 
actually  engage  in  such  an  operation,  the  first  thing  to  strike 
our  attention  is  that  the  rate  in  Paris  for  demand  sterling 
might  easily  shift  quite  a  distance  during  the  five  or  six 
days  required  for  the  transit  of  the  franc  checks  from 
New  York  to  Paris.  Also,  the  rate  for  demand  sterling  in 
New  York  has  opportunity  to  move  before  the  sale  takes 
place  in  this  city  of  the  demand  drafts  on  London.  Thus, 
our  assumed  arbitrager  would  be  taking  two  risks  of  ex- 
change or  two  speculations.  In  view  of  the  slightness  of 
the  profits  usually  available  in  arbitrage,  the  element  of 
speculation  would  be  extremely  prominent  in  this  example. 

It  is  evident  that  here,  as  in  cases  of  exchange  investment 
and  borrowing,  the  speculation  may  be  eliminated  if  appro- 
priate transactions  in  futures  can  be  arranged.  At  the 
present  moment  the  arbitrager  of  our  example,  located 
at  New  York,  plans  to  buy  the  checks  on  Paris,  and  then 
six  days  hence  to  buy  demand  sterling  at  Paris,  and  finally 
to  sell  demand  sterling  at  New  York  two  days  hence.  If 
he  can  make  the  rates  for  these  transactions  determinate 
in  advance,  by  finding  a  seller  of  futures  in  Paris  and  a 


ARBITRAGE  425 

buyer  of  futures  in  New  York,  and  can  fix  these  rates  at 
satisfactory  figures  or  in  an  appropriate  relation,  it  is  clear 
he  can  carry  through  the  arbitrage  for  a  profit  and  without 
speculation.  In  other  words,  a  suitable  arrangement  of 
transactions  in  exchange  for  future  delivery  may  in  whole 
or  in  part  constitute  a  pure  arbitrage,  or  there  is  such  a 
thing  as  arbitrage  in  futures.  There  is  nothing  especially 
difficult  in  principle  about  such  operations.  In  principle 
they  are  alike,  but  naturally  a  large  number  of  combinations 
are  possible  and  much  ingenuity  may  be  exercised  in  find- 
ing them  out. 

Telegraphic  transfers  are  the  ideal  material  with  which 
the  arbitrager  may  work.  But  even  when  dealing  with 
these  he  may  undertake  certain  minor  and  incidental  specu- 
lations. To  him,  with  his  special  information,  these  specu- 
lations may  well  appear  safe  and  wise.  Nevertheless,  if 
any  chances  are  taken,  we  must  say  there  is  speculation. 
To  illustrate,  suppose  that  at  the  present  moment  informa- 
tion by  cable  shows  that  the  rate  in  Paris  for  sterling  tele- 
graphic transfers  stands  at  a  position  of  perfect  parity 
with  the  rate  for  the  same  kind  of  exchange  in  New  York. 
No  arbitrage  is  possible.  But  suppose  that  while  our 
New  York  banker  is  feeling  practically  certain  that  sterling 
cables  are  going  to  fall  during  the  remainder  of  the  day, 
he  receives  a  cablegram  saying  that  there  is  a  decided 
tendency  for  sterling  telegraphic  transfers  to  rise  at  Paris. 
This  suggests  (1)  a  sale  of  sterling  telegraphic  transfers 
at  Paris,  (2)  a  purchase  of  the  same  at  New  York,  and  (3) 
a  sale  at  New  York  of  cables  on  Paris.  Without  attempt- 
ing to  arrange  perfectly  definite  contracts  of  sales  and 
purchases  in  advance,  our  banker  acts  promptly  on  the 
strength  of  his  prognostications  and  cables  instructions 
to  Paris  to  sell  such  and  such  an  amount  of  sterling  tele- 
graphic transfers.  This  is  an  act  of  speculation.  It  de- 
volves upon  himself  to  complete  the  operation  by  adding 


426  FOREIGN  EXCHANGE 

the  two  transactions  at  New  York,  namely,  a  sale  of  cables 
on  Paris  and  a  purchase  of  cables  on  London.  If,  before 
concluding  these,  he  waits  through  a  part  of  the  day,  in 
the  hope  of  improving  his  rate  position  in  the  arbitration, 
he  commits  two  more  acts  of  speculation.  But  presumably 
he  knows  what  he  is  doing  and  will  come  out  well.  There 
is  reason  to  believe  this  extremely  prompt  form  of  arbitrage, 
arbitrage  by  anticipation,  so  to  say,  is  quite  the  regular 
thing.  The  arbitrager  by  anticipation  is  likely  to  get  the 
business  away  from  the  one  who  acts  with  less  speed.  His 
is  indeed  a  remarkable  line  of  money-making.  Incidentally, 
we  must  not  think  of  him  as  some  clever  individual  working 
in  and  out  among  the  great  banks.  He  is,  in  fact,  or 
tends  even  more  to  become,  one  of  the  great  institutions 
with  its  tremendous  volume  of  regular  business,  its  exten- 
sive information-gathering  machine,  its  many  foreign  con- 
nections, and  its  long  purse. 

§  101.  Arbitrage  in  stocks. — Many  issues  of  bonds  and 
stocks  have  an  international  market.  Dealers  are  contin- 
ually comparing  the  prices  of  such  securities  in  different 
countries  to  discover  opportunities  to  buy  cheap  and  sell 
dear.  As  between  any  two  countries,  we  cannot  tell  in 
which  the  price  for  a  given  security  is  the  higher,  without 
resort  to  the  value-ratio  between  the  two  national  curren- 
cies as  shown  in  the  current  exchange  rate,  or  one  of  the 
current  exchange  rates,  between  the  countries.  If  a  cer- 
tain stock  sells  for  80  soldas  in  Urallo  and  for  973  livos  in 
the  Empire  of  Ramko,  in  which  country  is  it  dearer?  As 
already  indicated  (page  401),  any  method  of  obtaining 
the  answer  reduces  itself  to  a  comparison  of  the  arbitrated 
with  the  actual  price  in  one  of  the  countries.  If  these 
are  the  same,  or  at  parit}*,  nothing  can  be  done;  but  if 
they  differ,  a  purchase  in  the  one  country  and  a  sale  in 
the  other  become  profitable.  These  two  transactions  will 
be  made  as  nearly  simultaneous  as  conditions  permit.     To- 


ARBITRAGE  427 

gether  they  constitute  what  is  known  as  an  arbitrage  in 
stocks. 

For  an  example,  suppose  the  following  data  lie  before 
a  New  York  operator. 

(1)  AB  common  stands  in  New  York  at $105% 

(2)  Sight  sterling  in  New  York 4.8740 

(3)  AB  common  is  quoted  in  London,  for  delivery 

six  days  hence,  at $108% 

The  London  quotation  is  not  a  mistake,  though  the  reader 
probably  expected  pounds  instead  of  dollars.  The  real 
price  at  which  a  share  of  any  kind  of  stock  changes  hands 
in  London  is  certainly  a  number  of  pounds  sterling,  but  it 
is  an  arbitrary  custom  in  that  city  to  quote  the  price  of 
leading  American  securities  in  American  dollars,  counting 
$5  the  equivalent  of  £1.  If  the  real  price  is  £25,  the  Lon- 
doner in  his  humorous  way  quotes  it  as  $125,  and  London 
knows  that  if  another  stock  is  quoted  at  $150,  what  it  can 
be  sold  for  is  £30.14 

London's  fictitious  dollar  prices  for  our  securities  in- 
terest the  arbitrager  only  as  indexes  of  the  real  prices. 

AB  common  at   $108% 

means  AB  common  at   (108%  -=-5) £  21% 

New  York's  arbitrated  Loudon  price  (or  the  London 
price  is  sterling  converted  or  translated  into  dollars)  be- 
comes $106.  This  because  21%  X  4.8740  =  106.15  This 
exceeds  New  York's  actual  price  of  $105%  by  %  of  a  point. 
Therefore,  the  indicated  arbitrage  is  a  purchase  in  New 
York  for  sale  in  London.     Each  share  will  cost  $105%  and 

14  Ours  are  not  the  onlj  securities  quoted  in  London  in  terms  of 
the  money  of  the  country  where  they  are  issued  and  made  payable. 
The  original  design  of  the  custom  was,  no  douht,  to  facilitate  a 
rough  and  ready  comparison  of  the  price  in  London  with  the  price 
in  the  United  States  itself. 

IB  Plus  the  decimal   .0005. 


•l-'S  FOREIGN  EXCHANGE 

will  yield,  through  such  foreign  sale,  $106.  Prom  the 
gross  profit  the  incidental  expenses  must  be  paid.  This 
example  is  a  mere  illustration,  for  a  profit  of  %  of  a 
point  exceeds  anything  obtainable  in  ordinary  practice. 

The  arbitrager  buys  the  stock  in  New  York  for  105% 
a  share,  ships  the  certificates  to  London  immediately  upon 
procuring  them,  and  draws  a  sight  draft  on  the  London 
buyer  for  an  amount  equal  to  £21%  times  the  number  of 
shares  shipped ;  this  because  the  Londoner  has  agreed  to 
take  the  stock  at  this  price  on  the  day  when  the  steamer 
will  arrive.  To  this  draft  the  stock  will  be  attached  for 
delivery  against  payment  of  the  instrument.  It  serves,  of 
course,  as  collateral  security.  £21%  of  sight  draft  sold 
at  4.8740,  the  current  rate  of  exchange  for  this  type  of 
bill,  yields  $106.00+. 


CHAPTER  XV 
COINAGE  LAWS  AND  EXCHANGE  RATES 

§  102.  The  several  monetary  standards. — In  the  next  five 
chapters  it  is  the  design  to  set  forth  so  much  of  the  prin- 
ciples of  money  as  seem  important  for  a  thorough  under- 
standing of  the  subject  of  specie  shipments.  To  begin  with 
we  must  distinguish  the  several  monetary  standards  known 
to  the  world.     The  list  comprises 

1.  The  gold  standard 

2.  The  gold-exchange  standard 

3.  The  silver  standard 

4.  The  bimetallic  standard 

5.  The  "fiat"  or  irredeemable  paper  standard 

Among  the  several  kinds  of  money  found  in  any  modern 
country,  one  serves  as  a  money  of  ultimate  redemption,  in 
the  sense  that  other  forms  are  redeemable  or  convertible 
into  it  by  government  agencies  at  fixed  ratios,  while  this 
one  is  not  in  this  manner  redeemable  in  anything,  although 
each  unit  is,  if  it  is  a  coined  metal  money,  practically 
convertible  into  an  almost  invariable  quantity  of  a  valuable 
bullion  by  the  method  of  melting  down  coin.  This  money 
of  ultimate  redemption  constitutes  what  is  known  as  the 
"standard  money."  "We  speak  of  a  country  as  having 
or  being  upon  a  certain  standard,  as  the  "gold"  standard 
or  the  "bimetallic  standard."  Here  we  use  the  word 
standard  in  the  sense  of  a  monetary  system  which  is  defined 
and  classified  in  accordance  with  the  character  of  the  stand- 
ard money  employed  in  it.     To  be  upon  the  gold  or  silver 

429 


430  FOREIGN  EXCHANGE 

standard  moans  to  have  a  gold  or  a  silver  money  of  ulti- 
mate redemption,  though  this  does  not  completely  define  the 
condition  of  being  on  these  standards.  To  be  on  the  bime- 
tallic standard  means  to  have  both  gold  and  silver  standard 
moneys  conjointly.  There  is  no  country  which  has  this  as 
a  working  system  to-day.  To  be  upon  the  gold-exchange 
standard  is  to  have  a  system  under  which  the  local  cur- 
rency is  inter-convertible,  at  some  officially  established 
and  nearly  invariable  rate,  with  exchange  (i.e.  bills  and 
drafts)  on  a  foreign  country  that  has  the  gold  standard. 
If  the  system  is  actually  maintained,  the  gold  money  of 
the  foreign  country  serves  as  the  real  money  of  ultimate 
redemption,  though  redemption  in  it  takes  place  in  an  in- 
direct manner  only.  The  irredeemable  paper  standard  is  a 
system  under  which  the  money  of  ultimate  redemption  is 
paper  which  is  itself  redeemable  in  nothing.  How  this 
kind  of  money,  which  has  been  and  is  very  common  in  the 
world,  comes  to  have  and  keep  a  purchasing  power  over 
services  and  goods,  real  wooden  and  iron  commodities,  has 
always  been  more  or  less  of  a  mystery  to  the  normal  mind, 
but  this  seems  to  be  only  because  the  normal  mind's  con- 
ception of  money  possesses  to-day  about  that  degree  of 
error  and  distortion  which  was  shown  say  in  the  Ptolemaic 
theory  of  the  solar  system.  If  this  offends  the  reader,  let 
us  not  debate  it,  since  in  any  case  nearly  all  our  energy 
henceforth  will  be  spent  in  explaining  the  operation  of  the 
exchanges  under  the  conditions  of  the  gold  standard.1 

i  The  exchange  rates  between  gold  and  silver  countries,  or  between 
gold  and  inconvertible  paper  countries,  or  between  silver  and  in- 
convertible paper  countries,  or  finally  between  one  inconvertible 
paper  country  and  another,  are  subject  in  part  to  different  principles 
from  those  which  apply  to  the  exchanges  between  any  two  gold 
standard  countries.  The  exchanges  between  two  silver  standard 
countries  would  be  subject  to  the  same  principles  as  those  applying 
to  gold  exchanges.  But  there  are  no  longer  any  true  silver-silver 
exchanges. 


COINAGE  LAWS  AND  EXCHANGE  RATES         431 

The  following  may  be  laid  down  as  the  conditions  which 
must  be  met  before  a  country  can  lay  claim  to  being  fully 
and  unreservedly  upon  the  gold  standard. 

In  Domestic  Relations 

1.  There  must  be  a  gold  money  of  ultimate  redemption, 

actually  available  and  not  merely  legally  authorized 
to  exist. 

2.  The  unit  of  this  must  be  a  fixed  (and  not  a  variable  2) 

physical  quantity  of  gold. 

3.  This  money  must  be  subject  to  the  right  of  free  coinage 

for  private  owners  of  bullion. 

4.  It  must  be  lawful  to  melt  down  this  money  at  will. 

5.  The    collateral   or   subsidiary   forms    of   money   must 

actually   be   maintained   at    parity   with  this   gold 
money. 

In  Foreign  Relations 

6.  There  must  be  no  legal  or  legally  recognized  inter- 

ference with  the  free  export   and  import  of  gold 
bullion. 

During  the  great  war  nearly  all  countries  prohibited  or 
laid  drastic  regulations  upon  the  export  of  gold.  Whereas 
the  United  States  undoubtedly  maintained  the  gold  stand- 
ard throughout  the  period  in  domestic  relations,  it  did  not 
maintain  it  in  foreign  relations,  because  it  prohibited  the 
free  export  of  the  metal. 

The  essence  of  the  gold  standard  is  the  convertibility  of 
the  unit  of  any  form  of  money  (as  the  dollar)  into  a  fixed 

2  Irving  Fisher's  plan  for  a  dollar  of  variable  gold  contents 
(which  could  of  course  circulate  only  by  paper  proxy)  would,  if 
internationalized,  it  is  believed,  give  us  a  better  monetary  Bystem 
than  the  gold  standard,  but  it  would  lie  idle  to  niiiintain  that  under 
this  scheme  we  would  still  be  on  the  gold  standard. 


432  FOREIGN  EXCHANGE 

physical  quantity  of  gold  metal  at  the  will  of  the  holder, 
and  its  counterpart,  the  convertibility  of  this  same  quan- 
tity of  the  metal  into  the  unit  of  money  at  the  will  of  the 
holder  of  the  metal.  It  is  the  interchangeability  of  the 
fixed  amount  of  the  metal  and  the  money  unit  in  all  its 
forms.  In  some  instances  certain  subsidiary  forms  of 
money  are  maintained  at  a  parity  with  gold  money  as  a 
matter  of  fact,  without  their  possessing  strict  legal  re- 
deemability.  This  gives  rise  to  what  is  known  as  the  limp- 
ing gold  standard.     (See  §  124  following.) 

§  103.  Mint  pars  of  exchange. — What  is  commonly  called 
the  "value"  of  one  gold  money  unit  in  terms  of  another, 
depends  upon  the  relative  amounts  of  pure  or  "fine"  gold 
contained  in  the  two.  Thus  the  British  unit,  the  pound 
sterling,  is  said  to  have  a  value  of  $4.8665+  in  terms  of 
the  American  dollar,  because  the  pure  gold  required  to 
make  a  pound  sterling  of  coin  (namely  113.0015+  grains 
troy)  is  4866Jftoooo+  times  the  pure  gold  used  in  making 
a  dollar  of  United  States  coin  (namely  23.22  grains  troy). 
A  somewhat  objectionable  but  nevertheless  common  form  of 
statement  is  that  the  pound  sterling  has  a  "fixed  intrinsic 
value"  of  $4.8665+.  This  statement  has  no  further  mean- 
ing than  that  the  pound  sterling  of  coin  contains  4.8665 
times  as  much  pure  gold  as  the  dollar  of  coin  (the  coins 
of  both  countries  being  taken  as  defined  by  law  and  the 
small  errors  that  are  unavoidable  in  minting  being  disre- 
garded). The  best  name  for  the  figure  of  4.8665  is  the 
mint  par  of  exchange  between  England  and  the  United 
States.  A  formal  definition  of  this  term  would  run  as 
follows:  The  mint  par  of  exchange  between  two  countries 
is  the  number  of  the  standard  money  units  of  the  one 
country  which  contain  the  same  quantity  of  the  same  pure 
metal  as  the  standard  money  unit  of  the  other  country, 
both  money  units  being  assumed  to  have  the  exact  pure 
metal   contents   prescribed   by  law.     Regarding   the   mint 


COINAGE  LAWS  AND  EXCHANGE  RATES        433 

par  the  following  observations  should  be  noted:  (1)  There 
is  no  mint  par  between  countries  which  lack  a  common 
metallic  standard,  as  for  instance  between  a  gold  and  a 
silver  standard  country,  or  between  a  gold  and  an  incon- 
vertible paper  country.3.  (2)  There  are  two  ways  of  ex- 
pressing any  given  mint  par.  One  may  set  down,  for  in- 
stance, the  number  of  German  units  that  are  equal  to  one 
French  unit,  or  the  number  of  French  units  that  are  equal 
to  one  German  unit.     Thus : 

1  franc  =    .81  marks  (8Hoo  of  a  mark). 
1  mark  =  1.23  francs. 

This  recalls  the  two  principal  methods  of  expressing  any 
given  foreign  exchange  rate.  (3)  The  relative  average 
weights  of  actual  coin  in  circulation  may  be  (and  in  fact 
always  are)  different  from  the  exact  mint  par.  There 
are  two  causes  for  this  difference.  The  first  is  error  in 
minting.  It  is  impossible  for  mints  to  strike  coin  which 
shall  weigh  exactly  what  the  letter  of  the  law  requires, 
and  the  law  itself  provides  certain  narrow  limits  of  per- 
missible deviation  of  the  weight  of  newly  minted  coin 
from  the  exact  legal  standard.  The  amount  of  deviation 
allowed  is  in  this  country  called  tolerance.  There  is  also 
a  tolerance  granted  for  error  in  fineness.  In  the  second 
place  the  abrasion  or  wearing  down  of  coin  in  actual  cir- 

8  If  an  inconvertible  paper  country  lias  a  gold  unit  provided  for 
by  law  which,  however,  does  not  enter  into  actual  circulation,  it  is 
possible  to  give  the  figure  showing  the  relative  contents  of  this  unit 
compared  with  anj'  other  national  gold  unit.  Thus  the  laws  of 
Brazil  provide  for  a  standard  gold  unit  called  the  "Milreis"  con- 
taining 12.08+  grains  troy  of  fine  gold.  Therefore  one  milreia 
"equals"  5tioo  of  a  dollar,  and  8.01  milreis  "equal"  £1.  The  Report 
of  the  Director  of  the  Mint  (U.  S.)  gives  the  former  of  these  figures 
as  the  value  of  the  milreis  in  the  general  table,  "Value  of  Foreign 
Coins."  Such  a  figure  may  be  called  a  mint  par  if  one  insi-i~, 
but  it  does  not  have  the  sume  relation  to  exchange  rates  as  does 
the  normal   mint    pur. 


434  FOREIGN  EXCHANGE 

dilation  reduces  its  contents.  If  a  standard  coin's  loss 
of  weight  through  abrasion  becomes  too  great,  the  coin 
either  ceases  to  be  legal  tender,  or  else  it  becomes  legal 
tender  for  an  amount  in  proportion  to  its  weight  instead  of 
at  its  nominal  value.  A  certain  amount  of  abrasion  with- 
out loss  of  tender  power  at  its  nominal  value,  must  be 
tolerated  in  a  coin,  and  the  law  of  each  country  provides 
what  this  amount  shall  be.  While  therefore  according  to 
the  mint  par,  $48,665  of  gold  coin  of  the  United  States 
should  contain  the  same  amount  of  pure  gold  as  £10,000 
of  English  coin,  this  relation  would  not  hold  to  the  exact 
figure  in  case  actual  coin  is  compared  with  actual  coin. 
If  $48,665  of  American  gold  coin  drawn  from  circulation 
were  shipped  to  England  to  be  converted  into  new  English 
coin  it  would  in  practice  fall  short  of  a  weight  sufficient  to 
produce  a  full  £10,000  of  new  English  money.  It  would 
be  equally  true  of  course  that  £10,000  of  English  coin  taken 
from  the  channels  of  trade  and  shipped  to  the  United  States 
would  be  on  the  average  incapable  of  making  the  full 
$48,665  of  new  American  standard  money.  (4)  Mint  pars 
are  not  affected  by  seigniorage  and  brassage  charges,  or  by 
changes  in  these  charges,  so  long  as  the  contents  of  the 
money  units  remain  unaltered.  If  the  German  mint  should 
change  its  seigniorage  charge  from  6  marks  to  60  marks 
per  kilogram  (see  §  134)  this  would  not  mean  that  the 
weight  or  fineness  of  German  gold  coin  would  be  modified, 
but  merely  that  the  government  would  return  to  the  pri- 
vate owner  of  the  bullion  brought  in  for  coinage,  a  smaller 
share  of  coin  than  before,  reserving  a  larger  share  for 
itself.  For  either  France  or  Germany  to  change  its 
seigniorage  would  have  no  effect  upon  the  mint  par  between 
these  countries,  since  it  would  not  affect  the  legal  weight 
of  their  coins,  but  it  would  affect  the  "gold  points"  be- 
tween them  as  it  would  affect  the  price  of  gold  bullion  in 
the  country  which  alters  its  seigniorage  (compare  Chapter 


COINAGE  LAWS  AND  EXCHANGE  RATES         435 

XX).  The  effect  of  a  very  great  seigniorage  would  be  to 
make  the  mint  par  cease  to  be  the  approximate  center  of 
oscillation  of  exchange  rates. 

§  104.  Mint  pars  distinguished  from  actual  values. — Gen- 
erally when  we  speak  of  the  "value"  of  one  thing  in  terms 
of  another,  we  mean  the  purchasing  power  of  the  first 
thing  over  the  second  in  actual  exchanges  on  the  market, 
this  purchasing  power  being  measured  merely  by  the 
quantity  of  the  second  thing  which  the  first  will  com- 
mand in  exchange.  It  is  only  proper  to  point  out  in  the 
present  connection  that  British  sovereigns  (or  coins  of  one 
pound  sterling)  will  virtually  never  show  a  purchasing 
power  over  American  dollars  at  the  exact  rate  of  4.8665 
in  actual  exchanges  of  coin  against  coin.  Sovereigns  and 
dollars  may  be  exchanged  against  each  other  directly  or  in- 
directly. We  would  have  an  instance  of  actual  and  direct 
exchange  in  case  an  American  traveler  should  take  his 
home  gold  coin  abroad  and  offer  it  for  sale  for  British 
money.  If  dealing  in  a  small  way  with  an  English  coin- 
broker,  the  traveler  might  find  himself  compelled  to  give 
up  as  much  as  .$4.95  in  return  for  one  sovereign.  The 
Bank  of  England  frequently  buys  American  gold  coin  in 
large  lots  from  dealers,  at  the  price  of  £3  16s.  41/6d.  per 
ounce  Troy  (gross  weight  of  the  coin).4  What  this  price 
per  ounce  means  as  a  price  per  dollar  of  actual  coin,  de- 
pends upon  the  condition  of  the  coin.  The  more  abraded 
it  is,  or  the  greater  the  deficiency  in  weight  allowed  in 
its  original  minting,  the  less  will  the  fixed  price  of  £3  16s. 
4M>d.  (or  £3.818  -+-)  per  ounce  mean  as  a  price  per  dollar. 
The  sale  of  American  gold  coin  of  exactly  full  legal  weight 
at  this  price  would  mean  an  exchange  of  about  $4.87Ms  Cor 
a  pound  sterling.     If  the  coin  had  a  deficiency  of  1-10  of 

*  The  bank  may  change  this  price  at  its  pleasure,  but  if  it  made 
the  price  too  low  the  owners  of  the  coin  would  decide  to  sell  it  as 
mere  gold  bullion.     See  §  131. 


lit!  FOREIGN  EXCHANGE 

1'.  in  weighi  it  would  take  about  $4.87%  to  buy  £1.  But 
in  all  instances  the  value  of  Hie  American  coin  in  actual 
ami  direct  exchange  for  British  sovereigns  is  likely  to  be 
something  different  from  the  precise  mint  par. 

In  speaking  of  actual  but  indirect  exchanges  of  dollars 
;i -;i  i nst  sovereigns,  we  have  reference  to  the  buying  and 
selling  of  foreign  exchange.  The  purchase  for  dollars  in 
New  York  of  a  cable  transfer  or  a  sight  draft  on  London, 
amounts  to  an  actual  exchange,  in  as  much  as  there  is  an 
actual  transfer  on  the  market  of  an  article  for  a  price,  (of 
a  draft  for  dollars5)  and  amounts  to  an  indirect  exchange 
of  dollars  against  sovereigns  because  when  the  buyer  gives 
up  dollars,  although  he  receives  something  convertible  into 
sovereigns  in  England  he  does  not  receive  sovereigns.  We 
already  know  that  exchange  rates  in  the  market  may  rest 
at  figures  other  than  the  mint  par.  In  fact  examination 
of  market  reports  will  disclose  that  the  exchange  rates 
show  no  disposition  to  favor  the  figure  of  the  mint  par, 
or  to  rest  upon  it  any  oftener  or  longer  than  upon  any 
other  figure.  The  rate  for  sight  drafts  on  London  has  no 
mobre  tendency  to  rest  at  4.8665  than  it  has  at  4.8765  or 
4.8590  or  any  other  figure  between  the  upper  and  lower 
limits  which  confine  its  fluctuations. 

In  a  word,  while  it  is  good  usage  to  refer  to  the  mint 
par  between  dollars  and  pounds  as  the  "value"  of  the 
pound  in  dollars  (or  vice  versa),  we  must  bear  in  mind 
that  actual  exchanges  of  dollars  and  pounds  against  each, 
other,  direct  or  indirect,  show  actual  values  in  an  eco- 
nomic sense,  and  these  values  are  not  commonly  located 
exactly  at  the  mint  par.  The  importance  of  the  latter 
figure,  however,  lies  in  the  fact  that  under  normal  condi- 
tions it  really  governs  the  relative  value  of  the  money 
units  in  actual  exchange,  in  the  sense  that  it  closely  con- 
strains the  movement  of  this  value.     What  one  can  ob- 

5  Or  for  bank  credit  convertible  into  dollars. 


COINAGE  LAWS  AND  EXCHANGE  RATES        437 

tain  for  home  coin  in  actual  sale  to  a  broker  or  bank 
abroad  depends  on  the  mint  par  and  certain  other  lesser 
factors  of  cost  and  profit  to  brokers  or  bankers.  What  an 
American  can  obtain  for  or  must  give  for  a  bill  of  ex- 
change on  England  depends  fundamentally  on  the  mint 
par  between  the  United  States  and  England  and  second- 
arily on  certain  other  factors.  The  mint  par  is  the  ap- 
proximate center  of  oscillation  of  the  sight  rate  of  ex- 
change between  any  two  gold  standard  countries,  in  times 
of  freedom  of  gold  shipments,  and  this  rate  can  get  only 
a  very  small  distance  away  from  the  par  in  either  direc- 
tion. In  the  ease  of  New  York  rates  on  London,  the  mint 
par  is  somewhat  to  one  side  of  the  point  midway  between 
the  upper  and  lower  limits  of  rate  fluctuation :  that  is,  as 
indicated  it  is  an  approximate  center  of  oscillation  of  sight 
rates.  For  reasons  that  will  appear  in  the  chapter  on 
gold  shipments,  the  lower  limit  is  at  a  greater  distance 
underneath  than  the  upper  limit  is  above  the  par. 

The  mint  par  itself  depends  wholly  on  the  national  coin- 
age laws  passed  by  the  governments  of  the  two  countries 
concerned.  This  explains  at  bottom  what  the  relation  is 
of  national  coinage  laws  to  exchange  rates.  The  English 
government  defines  the  pound  sterling  in  such  terms  as  to 
make  it  contain  113.0015  -f-  grains  of  pure  gold,  and  the 
American  government  has  defined  its  monetary  unit  in 
words  that  make  it  contain  23.22  grains  of  pure  gold.  The 
par  follows  from  these  legally  fixed  figures  and  cannot  be 
changed  except  by  a  change  of  legislation.  No  merely 
economic  force,  no  amount  of  alteration  in  the  supply  of 
or  demand  for  gold,  generally  or  locally,  could  have  the 
slightest  effect  on  the  mint  par. 

§  105.  Free  and  gratuitous  coinage. — Stated  as  briefly  as 
possible,  the  relation  of  the  mint  par  to  the  exchange  rates 
between  two  countries  is  this:  the  sight  rale  in  one  coun- 
try on  the  other  cannot  rise  more  than  a  certain  distance 


138  FOREIGN  EXCHANGE 

above  the  figure  of  the  mint  par,  because  further  rise  will 
be  checked  by  the  export  of  gold  from  the  country  where 
the  rale  is  rising.6  In  a  similar  way,  a  fall  of  the  rate 
will  be  checked  at  a  certain  point  beneath  the  par  by  the 
import  of  gold  into  the  country  where  the  rate  is  falling. 
The  influence  of  the  mint  par  upon  exchange  rates  is  con- 
fined to  its  regulation  of  these  upper  and  lower  limits, 
which  are  known  as  the  "gold  points." 

The  action  of  gold  shipments  to  confine  the  rise  and 
fall  of  exchange  is  dependent  upon  the  maintenance  in 
both  countries  of  what  is  known  as  the  system  of  free 
coinage.  For,  as  will  appear  more  fully  later,  the  func- 
tioning of  gold  shipments  in  this  manner  is  due  to  the 
fixity,  or  virtual  fixity,  of  the  price  of  the  metal  gold  in 
each  of  the  countries.  This  in  turn  is  conditioned  on  free 
coinage  in  each.  The  right  of  free  coinage  consists  in  the 
privilege  granted  any  owner  of  the  standard  money  metal 
to  present  the  same  to  the  government  mint  to  be  manu- 
factured into  coin  to  be  returned  to  him.  It  is  the  privilege 
of  having  bullion  coined  for  oneself  at  the  mint  in  quan- 
tities without  a  maximum  limit.  As  a  matter  of  con- 
venience to  the  mint,  a  minimum  limit  must  of  course  be 
set. 

As  the  phrase  is  commonly  used,  especially  in  economics, 
the  right  of  free  coinage  does  not  mean  the  right  to  have 
the  service  of  the  mint  without  charge.  Free  coinage  does 
not  mean  costless  coinage,  but  unlimited  coinage.  No. 
doubt,  however,  it  is  ordinarily  implied  in  the  idea  that 
there  should  be  no  greater  charge  made  at  the  mint  than 
one  sufficient  to  cover  actual  costs.  When  minting  is  per- 
formed without  charge  to  the  depositor  of  the  bullion,  it 
is  called  gratuitous  coinage.     As  a  matter  of  public  policy 

e  Hee  §  137.  We  use  the  terms  rise  and  fall  on  the  assumption  that 
the  exchange  rate  is  quoted  according  to  the  "direct"  method.  See 
§22. 


COINAGE  LAWS  AND  EXCHANGE  RATES        439 

England  and  the  United  States  strike  coin  gratuitously, 
but  nearly  all,  if  not  all,  other  gold  standard  countries 
make  a  moderate  charge  for  this  service. 

A  charge  levied  for  coinage  is  known  as  seigniorage.7 
If  merely  sufficient  to  cover  the  supposed  cost  to  the  mint, 
it  is  known  as  brassage.  The  modern  gold  standard  coun- 
try does  not  make  a  practice  of  exacting  a  seigniorage 
substantially  greater  than  brassage.8  To  illustrate  the 
usage  of  these  terms  we  would  say,  for  instance,  that  in 
England  and  the  United  States  the  coinage  of  gold  is  free 
and  gratuitous,  while  in  France  and  Germany  we  have 
the  system  of  free  coinage  with  a  brassage  charge.  Free 
coinage  is  also  referred  to  as  coinage  on  private  account 
because  the  coin  manufactured  under  this  system  belongs 
to  and  is  returnable  to  the  private  owners  of  the  bullion 
from  which  it  is  made.  The  subsidiary  forms  of  coin,  or 
token  moneys,  are  said  to  be  coined  on  government  account, 
because  the  government  purchases  the  required  metal  on 
the  open  market  and  proceeds  to  make  the  coin  for  itself 
or  for  its  own  account.  The  government  owns  this  coin 
after  it  is  struck,  and  puts  it  in  its  treasury  for  expendi- 
ture, or  for  exchange  against  other  forms  of  money  on 
demand. 

When  coining  is  done  on  private  account,  it  is  not  to 
be  understood  that  care  is  usually  taken  to  give  the  de- 
positor of  bullion  the  identical  coin  which  is  made  from 
his  own  particular  metal.  The  coining  value  of  his  de- 
posit having  been  ascertained,  the  duty  of  the  mint,  or 
the  great  bank  which  in  many  countries  acts  as  go-between, 

7  The  term  seigniorage  is  also  used  in  a  different  though  related 
meaning  to  indicate  the  profits  made  by  government  mints  from  the 
coinage  .of  their  subsidiary  or  token  metallic  moneys. 

8  The  highest  charge  made  anywhere  is  1%  of  the  value  of  the 
coin.  Most  countries  have  a  charge  ranging  from  about  %  of  1% 
upward.  Hec  table  on  pp.  976-7  of  Swoboda's,  "Die  Arbitrage," 
edit,  of  1909,  Berlin. 


IHi  FOREIGN  EXCHANGE 

is  fulfilled  simply  by  giving  him  the  amount  of  coin  which 
is  Ins  due.  It'  the  coining  value  (less  charges  if  there 
are  any)  turns  ou1  to  be  a  fractional  sum,  as  say  $5,837.30, 
token  money  must  of  course  be  used  to  pay  the  odd  part, 
as  the  $2.30  in  this  case.  It  should  be  understood  also 
that  a  depositor  may  take  his  returns  in  the  shape  of  a 
warrant  on  a  government  office,  or  a  check  on  a  bank,  or 
a  deposit  in  the  bank,  or  notes  issued  by  the  bank,  which  as 
go-between  has  purchased  his  bullion. 

§  106.  Standard  bullion:  the  two  chief  standards. — Gold 
coin  is  not  struck  from  pure  or  "fine"  bullion;  but  is 
in  present  times  made  from  bullion  which  is  either  %o 
or  XV\2  fine.  Metal  possessing  the  proper  degree  of 
fineness  to  be  made  into  coin  as  defined  by  law  is  known 
as  standard  bullion.  In  France,  Germany,  the  United 
States  and  the  majority  of  other  countries,  standard 
bullion  is  9io  fine ;  in  England  and  a  few  other  coun- 
tries 1H2.  A  fineness  of  %o  is  usually  expressed  by 
the  figure  .900,  signifying  of  course  900  parts  fine  in  a 
total  of  1,000  parts,  the  other  100  parts,  or  Moth,  being 
of  other  metal  (chiefly  or  wholly  copper).  A  fineness  of 
x%2  is  expressed  decimally  as  .916%.  The  copper 
or  other  extra  metal  is  called  the  alloy.  It  is  introduced 
into  the  gold  to  make  it  hard  and  durable.  The  standard 
bullion  of  the  United  States  is  permitted  by  law  to  contain 
both  copper  and  silver  alloy,  the  silver,  however,  not  to 
exceed  Vio  of  the  alloy  itself,  that  is,  10  parts  in  1,000 
of  the  whole  mass.  Under  this  rule,  small  amounts  of 
silver  found  in  the  gold  as  it  comes  from  the  mines  may 
be  left  in  to  count  as  part  of  the  alloy.  If  the  silver  ap- 
pears in  the  natural  bullion  in  sufficient  quantity  to  make 
it  pay  to  refine  it  out,  such  a  course  would  be  pursued  be- 
fore finally  presenting  the  gold  for  coinage.  Except  in 
connection  with  the  art  of  coinage,  the  word  "alloy"  is  not 
used  to  signify  one  element  (the  baser  one)  in  a  mixture 


COINAGE  LAWS  AND  EXCHANGE  RATES        441 

of  metals,  but  means  the  whole  mixture  itself.  Thus  for 
example,  brass  is  spoken  of  as  :'an  alloy  of  copper  and 
zinc. ' ' 

The  right  of  free  coinage  means  in  the  first  instance 
the  right  to  have  standard  bullion  {i.e.,  bullion  .900  or 
.916%  fine)  struck  into  coin.  If  the  mint  were  to  re- 
fuse to  receive  for  coinage  bullion  of  any  other  degree  of 
fineness,  the  owner  would  of  course  be  compelled  to  have 
it  standardized  at  a  private  refinery.  As  a  matter  of 
practice,  however,  some  of  the  mints  of  the  world  stand- 
ardize gold  as  well  as  coin  it;  and  exchange  coin  for  de- 
posits of  bullion  of  other  degrees  of  fineness  than  the 
standard.  There  are  a  number  of  rules  and  conditions 
governing  this  exchange,  and  these  differ  slightly  in  de- 
tail in  the  several  countries.  In  some  countries  having  a 
general  brassage  charge,  bullion  which  is  finer  than  the 
standard,  and  which  differs  from  the  standard  (except 
for  the  presence  of  negligible  quantities  of  impurities) 
only  by  the  lack  of  a  certain  amount  of  copper  as  alloy, 
will  be  accepted  at  the  same  rating  as  if  it  contained  the 
proper  amount  of  copper.  This  means  that  the  state  sup- 
plies the  copper  without  extra  charge.  In  other  words, 
if  a  man  owns  a  bar  containing  200  ounces  of  pure  gold, 
he  would  receive  just  as  much  for  it  if  the  200  ounces  of 
pure  gold  were  in  a  bar  .999  fine  as  if  they  were  in  a  bar 
exactly  standard  or  .900  fine.  It  would  not  make  his  bar 
.999  fine  fetch  any  more  at  the  mint  or  bank,  to  add  be- 
forehand enough  copper  to  bring  the  fineness  down  to 
.900.  The  United  States  mints,  however,  charge  the  de- 
positor of  bullion  for  the  copper  which  may  be  required 
to  bring  it  to  the  standard  fineness  of  .900.  After  the 
bullion  is  brought  to  the  standard,  the  United  States  con- 
verts it  into  coin  gratuitously.  For  the  refined  copper 
that  may  be  needed  our  mints  charge  the  owner  of  the 
bullion  2f  an  ounce  Troy.     This  is  at  the  rate  of  24^  per 


442  FOKKHiN   KXCHANUK 

pound  Troy,  and  29^  per  pound  avoirdupois.  At  this 
rate  the  copper  required  to  convert  a  fine  bar  to  standard 
gold  costs  a  little  over  1-10,000  of  the  value  of  the  fine  gold 
itself  figured  at  ^20.67  per  ounce.  Thus  the  charge  for  cop- 
per is  relatively  an  exceedingly  small  one. 


CHAPTER  XVI 

THE  MINT  PRICE  AND  THE  MARKET  PRICE  OF  GOLD 

§  107.  The  striking1  stability  of  the  market  price  of  gold. — 
By  the  price  of  any  given  thing  we  mean  the  quantity  of 
money  for  which  a  unit  of  that  thing  will  exchange.  By 
the  price  of  gold  we  mean  the  quantity  of  money  for  which 
a  unit  of  gold  bullion  will  exchange.  We  do  not  mean  by 
the  price  of  gold,  the  purchasing  power  of  gold  money 
over  commodities  in  general.  In  the  United  States  and 
England  gold  bullion  is  priced  by  the  troy  ounce.  In 
other  leading  countries  it  is  priced  by  the  kilogram.  In 
countries  which  have  the  gold  standard,  the  fact  that  the 
money,  in  terms  of  which  gold  bullion  is  quoted,  is  itself 
made  of  gold,  does  not  make  the  quotation  cease  to  be  a 
price.  The  fact  does,  however,  lead  to  the  one  striking 
consequence  that  the  price  of  gold  is  an  almost  invariable 
figure  in  a  gold  standard  country.  In  a  silver  or  paper 
standard  country  the  price  of  gold  does  not  show  any 
peculiar  fixity. 

The  principal  market  of  the  world  for  gold  is  in  Lon- 
don. Year  in  and  year  out,  under  all  ordinary  condi- 
tions, the  price  of  this  metal  will  remain  between  £3.  17s. 
9d.  and  £3.  17s.  lid.  per  ounce  1:/i2  fine.  The  utmost 
possible  range  of  variation  will  be  between  £3.  17s.  9d. 
and  £3.  18s.  Id. 

£3.  17s.  9d.  =  933  pence  per  ounce 
£3.  17s.  lid.  =  935  pence  per  ounce 
£3.   18s.     Id.  =  937   pence  per  ounce 

The    ordinary    range    from    933d.    to    935d.    per    ounce, 
amounts  to  less  than  14  of   1%   of  the  average   price   be- 

443 


H4  FOREIGN  EXCHANGE 

twees  the  figures,  and  the  extreme  range  of  the  price  un- 
der the  influence  of  unusual  banking  conditions,  amounts 
to  less  than  ,->  of  \°/o}  Taking  such  great  staple  com- 
modities as  wheat,  corn,  cotton,  steel,  or  copper,  we  find 
that  Hit1  highest  and  lowest  prices  touched  by  any  of  them 
within  a  single  decade  will  differ  by  an  amount  equal  to 
from  80  to  100%  of  the  price  midway  between  the  ex- 
tremes. Tn  other  words,  a  staple  commodity  may  have 
within  a  single  decade  a  price  range  of  200  times  that  of 
gold,  even  taking  the  price  of  gold  through  the  whole 
length  of  time  during  which  a  country  maintains  its  gold 
standard  statutes  unaltered. 

But  one  thing  can  change  the  limits  which  confine  the 
price  of  gold  in  a  country  which  has  the  gold  standard, 
and  this  is  a  change  in  the  legislation  of  that  country  or 
an  abandonment  of  its  execution.  Neither  the  discovery 
of  gold  in  the  same  abundance  as  coal  nor  the  entire  cessa- 
tion of  its  production,  would  of  themselves  have  any  effect 
upon  these  limits.  Either  of  such  extreme  eventuations 
wTould  doubtless  force  changes  in  money  legislation  and 
would  in  this  manner,  although  in  this  manner  only,  re- 
act on  the  price  of  gold.  According  to  the  estimates  of 
the  Bureau  of  the  Mint  of  the  United  States,2  the  world's 
production  of  gold  in  certain  selected  years  has  been  as 
follows : 


Product  in 

Value  of  Product 

Year 

Fine  Ounces 

in  U.  S.  Dollars 

1873 

4,563,000 

$  96,200,000 

1880 

5,148,000 

106,400,000 

1890 

5,749,000 

118,800,000 

1900 

12,300,000 

254,500,000 

1909 

21,900,000 

454,400,000 

i  The  price  of  gold  in  dollars  has  in  the  New  York  market  to-day 
even  a  narrower  range  than  this. 

2  Report  of  the  Director  of  the  Mint    (U.  S.)5  1910,  p.   100. 


MINT  PRICE  AND  MARKET  PRICE  OF  GOLD     445 

Although  the  product  of  1909  is  nearly  five  fold  that  of 
1873,  the  price  of  gold  has  remained  unaffected  by  this 
increase. 

§  108.  The  mint  price  of  standard  bullion. — The  remark- 
able approach  to  fixity  which  we  find  in  the  market  price 
of  gold  is  simply  a  direct  consequence  of  the  absolute 
fixit}*  of  its  mint  price.  By  the  mint  price  of  gold  is  meant 
the  quantity  of  gold  coin  which  the  mint  of  a  gold  standard 
country  will  deliver  per  ounce  (or  other  physical  unit) 
in  exchange  for  gold  bullion  deposited  with  it  for  coinage. 
This  price  is  fixed  by  those  statutes  which  (1)  define  the 
national  standard  money  unit,  (2)  establish  the  system  of 
free  coinage,  and  (3)  set  the  charge,  if  any,  to  be  levied 
by  the  mint  for  converting  bullion  into  coin.  In  the 
United  States,  for  example,  the  standard  money  unit  is 
defined  as  25.8  grains  (troy)  of  gold  9-10  fine,  and  is 
given  the  legal  name  "dollar."  The  right  of  private  per- 
sons to  have  their  bullion  converted  into  coin  by  the  gov- 
ernment mint  was  first  laid  down  in  the  original  coinage 
act  of  the  United  States,  passed  April  2,  1792.  The  right 
of  free  coinage  was  in  the  beginning  given  to  owners  both 
of  gold  and  silver  bullion.  The  present  law  governing 
the  matter  is  the  Act  of  Feb.  12,  1873,  which  explicitly  con- 
firms the  right  of  free  coinage,  but  confines  it  to  gold 
alone.  Since  1875  the  mints  of  the  United  States  have 
converted  standard  bullion  into  coin  without  charge  to 
the  depositor  of  the  bullion.  In  virtue  of  these  several 
statutes  the  mint  price  of  standard  gold  is  fixed  at 
$18.60465  +  per  ounce. 

The  statutes  do  not  expressly  declai'e  that  this  figure 
shall  constitute  the  mint  price  of  gold,  but  their  provisions 
of  necessity  imply  it.  Since  it  is  declared  that  one  dollar 
of  coin  shall  contain  25.8  grains  of  standard  gold,  it  is  a 
mere  matter  of  arithmetic  that  one  ounce  of  this  gold  will 
make     1869ioo     dollars.     There     are     480     grains     in     an 


1  M  FOREIGN  EXCHANGE 

oum-c  and  25.8  is  contained  186(Moo  -f-  times  in  480. 
By  providing  for  the  "free"  and  "gratuitous"  coinage 
of  standard  bullion  the  statutes  make  it  compulsory  for 
the  mint  to  deliver  this  sum  of  coined  money  per  ounce 
to  the  depositor  of  standard  bullion.  Thus  $18.60-4-  be- 
comes the  mint  price  of  standard  gold  per  ounce  troy.  If 
the  statutes  of  the  United  States  should  be  altered  so  that 
the  definition  of  the  dollar  or  "standard  unit  of  value" 
should  become,  say,  48  grains  of  gold  9io  fine,  this 
would  change  the  price  of  gold  in  this  country  to  $10  per 
ounce  of  standard  bullion,  for  then  1  ounce  of  gold  would 
make  just  10  units  or  dollars  (480  grs. -^48  grs.  =  10). 
If  the  United  States  should  suspend  the  free  coinage  of 
gold,  while  continuing  the  use  of  gold  coin  as  standard 
money,  this  would  abolish  the  mint  price  of  gold,  and 
would  leave  the  market  price  of  the  metal  free  to  fall  be- 
low $18.60  and  to  fluctuate  on  this  lower  side  in  much  the 
same  manner  as  other  prices.  Such  an  action  would 
amount  to  an  abandonment  of  the  gold  standard. 

§  109.  The  mint  price  of  fine  bullion. — In  every  gold 
standard  country  the  mint  price  of  standard  bullion  de- 
pends upon  the  same  legal  elements  as  those  pointed  out 
in  the  illustration  of  the  United  States.  In  most  coun- 
tries, however,  it  is  affected  by  a  brassage  charge  for  coin- 
ing.3 The  mint  price  for  fine  as  distinguished  from  stand- 
ard gold,  is  simply  deduced  from  that  for  standard  gold. 
Take  for  example  the  figures  for  the  United  States.  One 
ounce  of  standard  gold  contains  9-10ths  of  an  ounce  of 
fine  gold,  or  10  ounces  of  standard  bullion  contain  9  ounces 
of  fine  gold. 

1  ounce   of  standard  bullion  =  $  18.60456  -4- 
Theref ore  10  ounces  of  standard  bullion  =   186.0465  -4- 

3  See,  for  instance,  sections  to  follow  on  the  monetary  systems 
of  France  and  Germany. 


MINT  PRICE  AND  MARKET  PRICE  OF  GOLD     447 

Therefore    9  ounces  of  fine  gold  =    186.0465  -f- 

Therefore    1  ounce    of  fine  gold  =     20.6718  -4- 

9)186.0465  + 

20.6718  -f 

In  this  manner,  we  calculate  what  is  called  the  "mint 
price  of  fine  gold, "  to  be  $20.67  +  per  ounce.  It  is  not 
to  be  understood,  however,  that  perfectly  pure  or  fine  gold 
is  offered  for  sale  at  the  mint.  It  is  questionable  if  ab- 
solutely pure  gold  can  be  produced.  The  so-called  "mint 
fine"  bars  used  in  international  gold  shipments  commonly 
have  had  in  recent  years  a  fineness  of  .999  or  better,  and 
not  long  ago  they  varied  between  .992  and  .999.  A  new 
process  of  refining  accounts  for  this  change.  Gold  which 
is  refined  to  the  most  extreme  purity  possible  and  which 
is  desired  for  chemical  or  other  special  purposes,  has  to 
bear  an  exceptionally  high  price  to  cover  the  expenses 
necessarly  incurred  in  getting  rid  of  the  last  elements  of 
impurity.  Thus  the  mint  price  of  fine  gold  is  not  to  be 
taken  literally  as  a  rate  per  ounce  at  which  absolutely  pure 
gold  is  in  practice  sold  to  the  mint.  For  such  sales  are  not 
made  in  fact.  It  is  merely  the  base  price  for  rating  the 
coining  value  of  the  pure  gold  which  is  contained  in  the 
bullions  of  varying  degrees  of  fineness  which  are  in  prac- 
tice presented  to  the  mint.  Thus  a  thousand  ounces  of 
bullion  .995  fine  will  contain  995  ounces  of  pure  gold.  .995 
multiplied  by  $20.67  -j-  gives  us  the  basic  value  of  the  bar, 
while  a  bar  of  a  thousand  ounces  .850  fine  would  contain 
only  850  ounces  of  pure  gold,  and  would  have  a  basic 
value  of  850  X  $20.67  4-.  Whether  a  given  bar  possesses 
its  full  basic  value  for  actual  sale  to  the  mint  depends 
upon  whether  any  expenses  have  to  be  paid  out  of  this 
value  by  the  owner  to  make  the  bar  finally  acceptable  for 
coinage.  Information  on  this  subject  will  be  found  in  the 
sections  devoted  to  the  detail  of  the  monetary  systems  of 
the  leading  countries. 


ll>  FOREIGN  EXCHANGE 

§  110.  The  market  price  of  gold.— Where  there  is  organ- 
ized and  continuous  dealing  in  gold  bullion,  the  competi- 
tion of  buyers  and  sellers  establishes  the  market  price  of 
gold.  Gold  dealers  have,  of  course,  a  lawful  right  to  trade 
at  any  prices  they  see  fit  to  make,  but  in  a  gold-standard 
country  they  will  never  see  fit  to  make  prices  more  than 
a  small  fraction  of  1%  away  from  the  mint  price.  The 
mint  price  being  rigidly  fixed,  this  accounts  for  the  re- 
markable steadiness  of  the  market  price  of  the  yellow 
metal. 

That  the  market  cannot  stand  very  much  below  the  mint 
price  is  evident  because  every  holder  of  bullion  (except  in 
undersized  lots)  has  the  option  of  exchanging  it  for  the 
mint  price  by  the  simple  method  of  depositing  it  at  the 
mint  for  coinage.  He  could  not  be  expected  to  take  less 
than  $20.67  a  fine  ounce  in  the  United  States,  when  a  fine 
ounce  will  make  20.67  dollars  of  gold  coin  all  of  which 
will  be  delivered  over  to  him.4 

Again,  so  long  as  a  country  is  on  the  gold  standard,  the 
market  price  of  gold  metal  cannot  rise  appreciably  above 
the  mint  price  for  the  reason  that  the  metal  can  always 
be  obtained  at  substantially  the  mint  price  by  the  method 
of  melting  down  gold  coin.5 

In  the  first  place,  if  the  gold  standard  prevails,  a  unit 
of  any  kind  of  lawful  local  money  can  be  converted  at  will 

*  Except  for  the  very  small  charge  for   standardizing  the   bullion. 

5  The  notion  sometimes  held  by  the  man  on  the  street  that  it  is 
unlawful  to  melt  coin  is  erroneous. 

A  country  might  be  on  the  gold  standard  without  having  actual 
gold  coins  suitable  for  circulation.  In  this  case  it  would  have  paper 
notes  or  certificates  representing  the  gold  in  the  circulation,  which 
would  be  procurable  by  a  citizen  only  through  giving  up  a  fixed 
physical  quantity  of  bullion  and  which  would  be  redeemable  in  this 
same  (or  nearly  the  same)  physical  quantity  of  bullion.  Here  the 
price  of  gold,  namely  the  exchange  rate  between  gold  metal  and 
money,  would  be  invariable. 


MINT  PRICE  AND  MARKET  PRICE  OP  GOLD     449 

into  a  unit  of  gold  coin.  In  the  second  place,  if  this  coin 
has  the  exact  weight  and  fineness  prescribed  by  law,  the 
metal  which  it  will  yield  when  melted  down  will  cost  pre- 
cisely the  mint  price.  This  is  a  mere  matter  of  mathe- 
matical necessity. 

Thus  suppose  that  instead  of  buying  $1,000  worth  of 
gold  metal  in  the  open  market  a  manufacturing  jeweler 
melts  100  U.  S.  eagles  or  $10  pieces  of  full  legal  tender 
value.  The  ingot  of  bullion  obtained  obviously  costs 
$1,000,  for  $1,000  of  money  had  to  be  surrendered  to 
secure  it.  If  the  coin  is  of  full  weight  and  fineness,  it  will 
contain  23.22  grains  of  fine  gold  per  dollar,  or  a  total  of 
23,220  grains.  This  makes  48%  or  48.375  ounces  Troy 
(23220 -=-480),  and  if  48%  ounces  cost  $1,000  each  ounce 
costs  $20.67.  This  matter  hardly  calls  for  extended  argu- 
ment. 

If  a  full  weight  gold  coin  is  melted  it  yields  an  ingot 
of  standard  metal  which  can  be  converted  back  into  the 
same  coin  at  the  mint,  and  therefore  the  metal  is  worth 
a  mint  price  equal  to  that  coin,  so  that  when  the  coin  as 
such  was  destroyed  to  get  the  metal,  the  metal  costs  ex- 
actly its  mint  price. 

The  practical  resort  to  the  plan  of  melting  coin  almost 
always  involves  a  small  increase  in  the  cost-price  of  the 
bullion  procured,  by  reason  of  the  coin's  being  a  trifle 
short  of  full  content.  The  chief  cause  of  this  condition 
is  abrasion  in  circulation.  A  very  minor  cause  is  error 
in  minting.  Suppose  the  100  eagles  of  the  preceding  illus- 
tration lack  50  grains  of  their  full  fine  contents  I  being  thus 
a  little  over  %  of  1%  short),  and  therefore  weigh  23,170 
grains  fine.  If  23,170  grains  cost  $1,000,  the  rate  is  at 
$20.71  per  fine  ounce. 

The  foregoing  is  a  mere  illustration,  but  it  serves  to 
show  that  the  theoretical  upper  limit  of  the  market  price 
of  gold  is  a  certain  small  distance  above  the  mint  price — 


450  FOREIGN  EXCHANGE 

a  distance  depending  to-day  primarily  on  the  average  de- 
gree of  abrasion  of  actual  coin.6 

Under  conditions  where  an  abundance  of  new  gold  flows 
from  the  mines  into  the  channels  of  commerce,  the  amount 
of  melting  down  of  coin  is  much  restrained.  Perhaps  in 
present  da}'S  over  two-thirds  of  the  world's  new  gold  goes 
into  the  money  use.  The  demand  for  the  one-third  put 
to  the  manufacturing  and  arts  uses  is  doubtless  in  great 
part  satisfied  b}^  a  direct  application  of  new  and  uncoined 
bullion  to  these  uses.  The  Bureau  of  the  Mint  (U.  S.) 
gives  the  following  estimates: 

In  1909 

Value  in 

Pine  Ounces  U.  S.  Dollars 

World's  production  of  gold  7 21,980,000  $454,000,000 

World's  coinage  of  gold  8 15,150,000  313,000,000 

World's     industrial     consumption     of 

gold9    6,893,000  142,000,000 

Amount  of  gold  coin  used  in  the  arts 

in  U.  S.10 3,500,000 

One  should  bear  in  mind  that  industrial  "consumption" 
does  not  necessarily  mean  the  destruction  of  gold  or  even 
the  fabrication  of  gold  into  forms  which  preclude  its  re- 
turn to  the  money  use.  Much  old  manufactured  gold  re- 
turns to  the  mints  of  the  world  for  coinage.  Also  it  should 
be  noted  that  the  world's  industrial  "consumption"  of 
gold  in  any  given  year  does  not  have  to  come  out  of  the 
new  product  for  that  particular  year,  as  the  immense  ex- 
isting stock  may  be  drawn  upon. 

e  Compare  §   128,  pp.  489-91,  on  "tolerance"  in  the  United  States. 
7  Report  of  the  Director  of  the  Mint  for  1910,  p.  100. 
s  The  same,  p.  61. 
»  The  same,  p.  59. 
io  The  same,  p.  57. 


MINT  PRICE  AND  MARKET  PRICE  OF  GOLD     451 

§  111.  The  fluctuating  purchasing  power  of  gold. — "We 
perceive  that  the  fixity  of  the  price  of  gold  is  due  to  the 
fact  that  gold  bullion  is  quoted  in  terms  of  the  gold  coin 
into  which  it  is  freely  convertible  under  the  system  of  free 
coinage.  The  fixity  of  the  price  of  gold  is  not  a  sign  of  a 
fixed  economic  value.  One  must  not  infer  that  the  steady 
price  of  gold  gives  at  least  some  indication  of  the  stead- 
iness of  its  value.  The  truth  is  it  shows  nothing  what- 
soever about  the  value  of  gold,  if  we  mean  by  the  value 
of  gold,  as  we  should,  its  purchasing  power  over  other 
things,  that  is,  over  the  mass  of  other  goods  or  commodi- 
ties. The  rise  or  fall  in  the  purchasing  power  of  gold 
coin  is  shown  solely  in  the  fall  or  rise  of  the  general  aver- 
age of  the  prices  of  all  commodities.  To  illustrate  the 
point,  let  us  consider  the  purchasing  power  of  gold  coin 
over  some  one  commodity,  as  wheat.  If  the  price  of  wheat 
is  $1  a  bushel,  a  gold  dollar  has  the  power  to  purchase  1 
bushel.  If  the  price  rises  to  $2  a  bushel,  the  purchasing 
power  of  the  dollar  declines  to  Vi  bushel,  and  if  the  price 
falls  to  50^  a  bushel,  the  dollar's  purchasing  power  as- 
cends to  2  bushels.  To  double  a  price  cuts  the  purchas- 
ing power  of  the  money  unit  to  one-half;  to  cut  a  price 
to  one-half  doubles  the  money  unit's  purchasing  power. 
We  express  this  by  stating  that  the  value  of  money  in 
terms  of  any  one  commodity  varies  inversely  as  the  price 
of  that  commodity.  The  value  of  money  in  terms  of  all 
commodities,  or  commodities  in  general,  varies  inversely 
with  the  average  movement  of  the  prices  of  all  commodi- 
ties. 

If  we  are,  for  instance,  able  to  say  that  in  the  last  de- 
cade the  prices  of  goods  generally  have  gone  up  about 
1-3,  or  to  4-3  as  high  as  they  were  ten  years  ago;  we 
should  then  also  affirm  that  the  general  purchasing  power 
of  money  is  %  as  much  as  it  was  10  years  ago.  There  are 
many  difficult  and  interesting  problems  involved  in   the 


452  FOREIGN   EXCHANGE 

task    of   getting   a    statistical   record   of  the   variations   of 
prices  and  the  purchasing  power  of  money.11 

The  point  with  which  we  are  concerned  here  is  that  the 
purchasing  power  of  gold  may  change  and  that  while 
tli is  purchasing  power  is  changing,  no  matter  how  much 
it  is  changing,  the  price  of  gold  will  remain  as  nearly  in- 
variable as  ever.  Not  far  back  we  pointed  out  the  fact 
which  is  at  first  thought  somewhat  surprising,  that  except 
within  exceedingly  narrow  limits,  the  price  of  gold  is  not 
affected  by  changes  in  the  supply  of  and  demand  for  that 
metal.  It  is  to  be  understood  that  changes  in  supply  and 
demand  may  indeed  have  an  indefinitely  great  effect  upon 
gold,  but  only  upon  its  value,  or  purchasing  power,  as  dis- 
tinguished from  its  price.  The  answer  to  the  question, 
what  does  the  fixity  of  the  price  of  gold  show  with  respect 
to  the  value  of  gold — value  being  used  in  the  sense  of 
purchasing  power — is  that  it  shows  nothing  whatever. 

11  Series  of  figures  which  show  the  movement  of  general  prices, 
or  of  "the  general  price  level,"  are  called  index  numbers.  Among 
the  best  books  on  this  subject  are,  "The  Measurement  of  General 
Exchange  Value,"  by  C.  M.  Walsh,  and  "The  Fundamental  Problem 
of  Monetary  Science,"  by  the  same  author,  and  "The  Purchasing 
Power  of  Money,"  by  Irving  Fisher.  An  excellent  book  is  also 
"Money  and  Credit  Instruments  in  Relation  to  General  Prices,"  by 
E.  W.  Kemmerer.  See  also  "Making  and  Using  of  Index  Numbers," 
by  W.  C.  Mitchell,  in  Bulletin  of  U.  8.  Bureau  of  Labor  Statistics, 
Xo  173,  July,  1915,  pp.  5-1U. 


CHAPTER  XVII 

STANDARD  MONEY 

§  112.  The  several  forms  of  money  in  a  modern  monetary 
system. — Every  modern  country  has  a  number  of  forms 
of  money,  some  of  which  are  accounted  for  by  reasons  of 
commercial  convenience,  others  by  reason  of  economy  of 
maintenance  in  circulation,  still  others  by  reasons  touch- 
ing the  fiscal  necessities  of  the  government.  Any  gold- 
standard  country  will  be  found  to  possess  to-day  either 
all,  or  a  large  part,  of  the  several  forms  of  money  shown 
in  the  table  on  page  454. 

§  113.  Standard  and  representative  money. — The  fore- 
going fall  into  the  two  grand  classes  of  standard  and  rep- 
resentative money.  To  define  the  latter  first,  representa- 
tive money  comprises  all  those  forms  which  have  their  value 
determined  by  the  value  of  the  standard  money.  A  repre- 
sentative money  is  one  which  is  kept  in  a  legally  fixed  value 
ratio  with,  or  "at  a  parity"  with,  the  standard  money.1 
It  is  in  this  sense  "representative"  of  the  standard 
money.  The  best  method  of  maintaining  the  parity  of 
collateral  forms  of  currency  is  to  provide  for  their  con- 
stant and  direct  redemption  in  the  money  which  they  repre- 
sent. Were  this  method  universally  followed,  it  would 
be  best  to  give  the  class  the  name  of  "redeemable  money." 
But  in  practice  other  means  than  direct  redemption  are 
sometimes  made  to  suffice  in  maintaining  parities,  and  so 
we  must  be  content  with  the  less  definite  name  of  "repre- 
sentative money." 

i  Or  is  designed  to  be  kept  at  this  parity. 

4f.:i 


454 


FOREIGN   EXCHANGE 


FORMS  OF  MONEY  FOUND  IN  THE  MODERN  GOLD 
TANDARD  SYSTEM 


Stand- 
ard 


United 
States 

Gold  Coin 


Pre-war  Examples 

England      Germany 


Gold  Coin   Gold 
Coin 


Money   j 


Metal- 
lic or 
"Token" 


Repre- 
senta- 
tive 


Paper, 


•    Of 
Govern 

inent 


'Circu- 
lating - 
Prom. 
Notes 


Silver 
Dollar 

Subsidiary 
Silver 

Minor 
Coin 
(nickel 
and 
copper) 

U.  S.  Notes 
(Treasury 
Notes  or 
"Greenbacks") 


Of 

\Banks 


Money 
Certificates 


National 
Bank 
Notes 

Federal 
Reserve 
Bank 
Notes 

Federal 
Reserve 

Notes 

fGold  Certifi- 
cates 

Silver  Certi- 
ficates 


Silver  Silver 

Change        Change 

Nickel 
Change 

Bronze        Copper 
Change        Change 


Imperial 
Treas- 
ury 
Notes 

Reichs- 
bank 
Notes 


Bank  of 
England 
Notes 


Joint  Other 
Stock  Bank 

Bank  Notes 

Notes 


By  standard  money  we  mean  simply  the  represented 
money,  or  the  form  of  money  with  which  all  the  others  are 
maintained  at  a  parity.  And  the  only  fundamental  dis- 
tinguishing feature  of  standard  money  lies  in  this  single 
fact  that  other  forms  of  money  are  kept  at  a  parity  with 
it,  while  there  is  no  other  form  of  money  with  which  it  is 


STANDARD  MONEY  455 

kept  at  a  parity.  It  is  true  our  literature  affords  other 
definitions.  Jevons,  for  example,  makes  the  test  of  stand- 
ard money  that  its  value  in  exchange  should  depend  solely 
upon  the  value  of  the  material  contained  in  it.2  To  ac- 
cept this  would  prevent  our  speaking  of  a  "fiat"  or 
"paper  standard"  money,  since  the  value  of  such  a  money 
is  entirely  independent  of  its  material  contents.  In  point 
of  fact  we  find  the  use  of  the  term  fiat  standard  money 
so  convenient  as  to  be  practically  compulsory.  There  is  no 
need  of  adopting  the  definition  of  Jevons,  for  according 
to  him,  many  countries  do  not  have  a  standard  money ! 
The  workable  conception  is  simply  that  standard  money  is 
the  money  of  ultimate  redemption. 

§  114.  Approved  characteristics  of  standard  money. — It  is 
true,  general  opinion  has  it  that  standard  money  ought  to 
possess  certain  other  well  marked  attributes  or  characters 
besides  being  the  money  of  ultimate  redemption.  It  is 
generally  agreed  it  should  be  a  metal  money  and  gold  at 
that.  It  is  held  it  should  be  subject  to  the  right  of  free 
coinage,  or  coinage  on  private  account,  without  a  greater 
seigniorage  charge  than  brassage,  and  should  thus  possess 
substantially  full  bullion  value.  To  affirm  the  expediency 
of  these  characteristics  is  not  to  admit  them  as  elements 
in  the  definition  of  standard  money.  The  money  of  ulti- 
mate redemption  should,  and,  so  far  as  the  writer's  knowl- 
edge extends,  always  does  possess  full  legal  tender  power. 
But  this  is  not  distinctive  of  standard  money  since  in- 
stances abound  where  representative  moneys  possess  this 
power  as  well. 

To  summarize,  the  following  statements  hold  true  of 
what  is  generally  regarded  as  the  highest  type  of  standard 
money,  the  type  that  has  been  possessed  by  the  leading 
financial  and  commercial  nations. 

2  "Money  and  the  Mechanism  of  Exchange,"  p.  74. 


466  FOREIGN   EXCHANGE 

L)  It  is  gold. 

(2)  It  is  subject    to  free  coinage. 

(3)  It  has  (as  a  consequence)  full  bullion  value.3 

(4)  It  has  full  Legal  tender  power. 

§  115.  Commodity  and  fiat  standard  money. — There  are 
two  grand  classes  of  standard  moneys.  The  one,  made  of 
a  valuable  substance,  as  gold,  under  the  system  of 
free  and  gratuitous  or  virtually  gratuitous  coinage,  may 
be  called  commodity  money,  this  being  a  term  already  in 
use  for  money  with  full  bullion  value.4  The  other,  made 
either  from  a  practically  valueless  substance,  as  paper,  or 
made  from  metal  with  less  value  than  the  coin  itself  and 
coined  only  on  government  account,  has  long  been  known 
as  fiat  money.  Fiat  money  is  usually  thought  of  as  being 
irredeemable  paper,  but  there  can  be  no  question  it  may 
also  be  a  money  made  of  metal.  If  a  government  with 
irredeemable  paper  should  take  to  making  the  individual 
pieces  in  the  form  of  aluminum  or  silver  sheets  with  ap- 
propriate marks  upon  them,  this  would  not  remove  its 
money  from  the  flat  class.  Nor  would  changing  these 
sheets  to  round  disks  called  coins  make  any  difference. 
When  in  1893  the  government  of  British  India  suspended 
the  free  coinage  of  the  silver  rupee,  this  money  became 
a  metal  fiat  money.  Within  four  j^ears  the  value  of  the 
rupee  coin  ascended  to  50%  above  the  value  of  its  metal 
contents.  That  is,  in  1897  the  average  rate  of  exchange 
for  the  year  in  India  on  London  was  about  15.35d.  This 
means  the  rupee   could  purchase  15.35   pence  of  British 

s  Signifying  that  the  ingot  of  metal  obtained  by  melting  any  of 
it  will  have  (substantially)  a  money  price  equal  to  the  amount  of 
money  melted,  e.g.,  a  $20  gold  piece  when  melted  becomes  an  ingot 
salable  for  $20.  There  is  no  magic  in  this  full  bullion  value.  It  is 
a  mere  incident  to  the  system  of  free  coinage. 

4  Compare  J.  F.  Johnson,  "Money  and  Currency,"  Chapter  ix, 
§§  116  and  117. 


STANDARD  MONEY  457 

gold.  At  the  average  price  of  silver  for  1897  in  the  cen- 
tral market  of  London,  the  metal  contents  of  the  rupee 
were  worth  as  bullion  about  lOH  pence.  The  rupee  had 
become  a  fiat  money  made  of  silver.  In  1899  the  Indian 
government  adopted  measures  to  maintain  the  rupee  at  the 
practically  constant  value  of  l-15th  of  a  pound  sterling. 
These  measures  were  of  a  character  to  place  India  on  the 
"gold-exchange"  standard.  At  the  same  time  the  English 
sovereign  was  made  legal  tender  in  India  at  the  rating  of 
15  rupees.  By  similar  measures,  the  government  of  Brazil 
has  usually  in  recent  times  maintained  its  paper  "milreis" 
at  the  value  of  l-15th  of  a  pound  sterling.  It  had  a  fiat 
money  made  of  paper  which  it  decided  to  place  in  a  con- 
stant ratio  with  a  foreign  gold  unit.  This  money  became 
virtually  and  indirectly  redeemable  in  gold,  and  will  con- 
tinue in  this  position  so  long  as  the  measures  of  the  gold- 
exchange  standard  are  upheld.  It  would  therefore  now 
seem  proper  to  classify  it  as  representative  money.  But 
these  measures  are  not  in  the  least  necessary  to  make  the 
rupee  and  milreis  have  a  value  in  the  sense  of  purchasing 
power  over  commodities,  and  a  value  wholly  independent 
of  the  material  of  which  these  moneys  are  made.  History 
simply  abounds  in  instances  which  show  the  permanent 
feasibility,  by  limitation  of  quantity,  of  maintaining  the 
value  of  an  entirely  irredeemable  money  (once  it  is  es- 
tablished in  customary  circulation)  above  and  wholly  in- 
dependent of  the  value  of  its  material/' 

Suppose  that  England,  while  allowing  her  monetary 
system  to  remain  otherwise  unmodified,  were  to  terminate 
the  free  coinage  of  gold.  Unless  the  government  should 
continue  to  coin  as  many  sovereigns  on  its  own  account  as 
would  have  boon  struck  under  free  coinage,  the  value  of 

r-  'I  li«-  greatest  collection  of  information  on  1  li is  point  known  to 
the  writer  is  to  be  found  in  "Staatliche  Thoorie  des  Geldes,"  by 
G.  F.  Knapp. 


158  FOREIGN  EXCHANGE 

the  sovereign  would  ascend  above  the  value  of  its  gold  con- 
tents. But  England  would  still  have  a  standard  money. 
It  would  have  a  fiat  standard  money  made  of  gold!  The 
thing  that  brings  a  slandard  money  within  the  fiat  class 
is  the  fact  that  the  value  of  the  money  pieces  comes  to  ex- 
ceed and  move  independently  above  the  value  of  the  ma- 
terial which  composes  them. 

Representative  moneys  generally  have  a  value  much  in 
excess  of  the  value  of  their  material  contents,  because  the 
standard  money  with  which  they  are  kept  at  a  parity  has 
this  superior  value.  In  other  words,  representative 
moneys  have  material  values  which  are  nothing  at  all  or 
which  may  be  greatly  reduced  compared  with  their  nom- 
inal or  redemption  values.  This,  however,  does  not  make 
them  belong  to  the  class  of  fiat  moneys.  For  this  term 
properly  applies  only  to  standard  moneys,  which  are  not 
themselves  redeemable  in  any  other  form  of  money. 

§  116.  Contrasts  in  respect  to  regulation  of  quantity. — 
The  commodity  and  flat  systems  of  money  differ  as  re- 
gards their  operation  or  behavior  in  two  respects.  And 
these  differences  are  of  fundamental  importance.  In  the 
first  place,  the  quantity  and  value  of  a  commodity  stand- 
ard money  are  matters  which  the  state  leaves  to  be  de- 
termined by  the  free  play  of  private  interests.  This  is 
not  the  case  with  fiat  money.  In  the  second  place,  a  com- 
modity money  is  exportable  as  bullion  to  settle  accounts 
in  other  countries,  while  a  fiat  money  is  not. 

The  effect  of  the  free  coinage  plan  of  providing  com- 
modity money  is  to  make  the  quantity  of  standard  money 
created  and  put  into  monetary  use  depend  simply  upon 
the  action  of  private  owners  of  bullion.  And  since  this 
money,  as  bullion,  has  commodity  uses  and  may  be  melted 
down  for  these  uses,  and  since  it  is  also  exportable  as  an 
article  of  value  to  other  countries,  the  quantity  of  it  which 
is  retired  from  circulation  depends  also  upon  the  free  ac- 


STANDARD  MONEY  459 

tion  of  private  owners  of  coin.  Since  both  the  entry  of 
gold  into  and  its  departure  from  the  money  reservoir,  de- 
pend wholly  on  business  conduct  and  not  upon  measures 
of  government,  the  quantity  of  the  standard  money  re- 
mains independent  of  state  regulation.  This  signifies  that 
the  value  of  this  money — its  purchasing  power,  as  shown 
in  the  general  level  of  prices, — likewise  remains  independ- 
ent of  state  regulation,  at  least  at  this  point  of  regulation.6 
In  legal  phraseology  it  is  said  that  the  government  "de- 
termines the  value"  of  standard  coin.  This  holds  only 
in  the  sense  of  determining  the  quantity  of  gold  contained 
in  that  coin.  Thus  the  United  States  statutes  provide  that 
the  "eagle"  shall  contain  258  grains  of  gold  %o  fine.  It 
is  not  uncommon  to  speak  of  this  as  a  determination  of 
the  "value"  of  the  coin.  Value  here  means  nothing  what- 
soever beyond  material  contents.  Without  tarrying  to 
argue  about  this  questionable  usage,  it  must  be  said  the 
value  of  the  money  unit,  in  the  sense  of  its  purchasing 
power  over  ordinary  goods,  is  something  wholly  different. 
Value  in  the  sense  of  material  contents  is  invariable  and 
fixed  by  law,  but  in  the  true  sense  of  purchasing  power, 
it  is  variable  and  in  countries  with  the  commodit}^  stand- 
ard, its  variations  are  independent  of  governmental  con- 
trol. Of  course  the  larger  the  metallic  contents  fixed  by 
the  government  for  the  money  unit,  the  larger  its  purchas- 
ing power  will  be,  but  once  the  contents  are  fixed  the  fu- 
ture course  of  purchasing  power  is  uninfluenced  by  the 
government. 

The  quantity  of  fiat  money,  once  the  system  is  running, 

o There  is  another  point  at  which  it  is  feasible  for  the  state 
greatly  to  influence  (though  hardly  to  regulate)  the  general  level 
of  prices  and  purchasing  power  of  money,  and  this  is  at  the  point  of 
control  of  the  expansion  or  contraction  of  bank  credit.  The  Amer- 
ican state  has  at  present  an  agency  which  can  exert  such  an  in- 
fluence, though  only  to  a  certain  extent,  in  the  shape  of  the  Federal 
Reserve  Board. 


460  FOREIGN  EXCHANGE 

depends  upon  the  amount  manufactured  by  the  govern- 
ment. It  has  been  the  custom  of  governments  to  manu- 
facture it  altogether  too  freel}7,  to  substitute  the  creation 
of  fresh  batches  of  it  for  the  collection  of  taxes.  Hence 
fiat  money  has  become  notorious  for  its  propensity  to  in- 
crease in  volume  and  depreciate  in  purchasing  power. 
Given  wisdom  of  control,  fiat  money  is  theoretically  su- 
perior to  a  commodity  money,  judged  from  the  standpoint 
of  social  welfare,  but  up  to  the  present  few  have  had 
much  confidence  in  our  ability  to  achieve  the  requisite 
wisdom  in  control. 

§  117.  The  quantity  of  money  and  its  value. — The  value 
of  money  depends  in  part  upon  the  quantity  of  money, 
and  if  the  state  desires  to  permit  the  quantity  of  money 
to  take  care  of  itself,  the  state  thereby  rejects  the  only 
means  open  to  it  fully  to  regulate  the  value  of  money.  The 
theory  of  the  state  is,  of  course,  that  to  leave  the  economic 
value  of  money  alone  is  the  course  of  wisdom.  At  the 
present  point  this  book  will  be  brief  and  therefore  by 
necessity  frankly  dogmatic.  The  value  of  money  depends 
in  part  upon  its  quantity  and  in  part  upon  the  volume  of 
exchanging,  or  volume  of  business,  or  amount  of  money 
work  to  be  done.  It  depends  also  upon  the  rapidity  of 
the  circulation  of  money,  and  upon  the  extent  to  which 
the  business  world  is  accustomed  to  use  credit  instruments 
as  substitutes  for  money  itself  in  effecting  exchanges. 
The  value  of  money  does  not  depend  solely  upon  the  quan- 
tity of  money,  but  the  quantity  of  money  is  the  one  factor 
among  all  those  we  have  named  which  we  might  conceive 
of  being  regulated  by  the  state.  Such  factors  as  rapidity 
of  circulation,  employment  of  credit  substitutes  to  effect 
exchanges,  and  the  volume  of  exchange  itself,  are  beyond 
government  control,7  though  the  use  of  credit  substitutes 

7  Furthermore,  these  factors  are  relatively  stable,  depending  upon 
business  and  banking  habits  that  are  quite  slow  to  change. 


STANDARD  MONEY  461 

is  not  wholly  beyond  governmental  influence.  We  may 
explain  the  substance  of  the  relation  of  the  quantity  of 
money  to  its  value — and  thus  give  the  substance  of  the 
so-called  quantity  theory — in  various  formulas.  Thus,  if 
at  any  given  time  (i.e.,  under  any  given  set  of  commercial 
conditions)  there  should  be  more  standard  money  than  in 
fact  there  is,  the  money  would  have  a  lower  value  than  it 
in  fact  has,  and  vice  versa.  Or  again,  other  things  remain- 
ing unchanged,  the  more  money  the  less  its  purchasing 
power,  and  vice  versa.  Essentially  the  same  proposition  is 
that  an  increase  in  the  quantity  of  money  tends  to  de- 
crease its  purchasing  power,  and  vice  versa.  The  latter 
form  of  statement  gives  perhaps  the  clearest  recognition 
to  the  fact  that  an  increase  in  the  quantity  of  money  may 
be  accompanied  actually  by  an  increase  in  its  value, 
or  a  decrease  by  a  decrease  in  its  value  (although  both 
of  these  are,  as  it  were,  contrary  to  expectation)  sim- 
ply because  other  factors  may  act  in  opposition  to  and 
overcome  the  tendency  of  the  change  in  the  quantity  of 
money.  The  doctrine  has  at  times  been  criticized  as  being 
"barren"  or  without  consequence.  It  is,  however,  both 
true  and  consequential.8  The  consequence  which  flows 
from  it  is  that  any  action  affecting  the  quantity  of  money 

b  In  general  the  quantity  theory  proves  of  basic  importance  in 
accounting  for  the  behavior  of  monetary  systems,  notwithstanding 
certain  misguided  attacks  made  upon  it  in  recent  times.  Should  a 
reader  unacquainted  with  the  literature  of  the  subject  desire  to 
examine  into  it,  he  would  do  well  to  begin  with  Irving  Fisher's 
"Purchasing  Power  of  Money,"  and  J.  F.  Johnson's  "Money  and 
Currency"  (appropriate  chapters),  and  pursue  references  found 
in  these  works  for  further  investigation.  These  are  works  which 
from  the  present  writer's  standpoint  may  be  recommended  as  giv- 
ing the  best  explanation  in  form  and  substance  of  the  quantity 
theory.  In  them  references  to  the  literature  of  criticism  of  the 
theory  will  be  found.  A  leading  critic  has  been  J.  L.  Laughlin. 
See  his  "Principles  of  Money."  Any  book  on  money  gives  some  at- 
tention to  the  subject. 


462  FOREIGN  EXCHANGE 

affects  its  value,  and  makes  its  value  different  from  what 
it  would  otherwise  have  been.  Indeed,  given  the  power  to 
regulate  the  quantity  of  money,  there  is  given  the  power 
to  regulate  its  general  purchasing  power  or  the  general 
level  of  prices,  despite  such  changes  as  can  take  place  in 
the  other  institutional  factors  which  help  determine  this 
level.  To  deny  the  significance  of  this  would  be  on  a  par 
with  denying  the  significance  of  the  proposition  that  con- 
trol of  the  supply  of  wheat  would  mean  control  of  its 
value,  on  the  grounds,  forsooth,  that  the  value  of  wheat 
also  depends  upon  the  demand  for  it.  No  government 
controls  the  demand  for  circulating  medium,  for  this  de- 
pends upon  the  volume  of  business.  But  in  the  case  of 
a  fiat  system  the  government  controls  the  supply  of  stand- 
ard money,  while  in  the  case  of  a  commodity  money  this 
supply  is  made  to  take  care  of  itself. 

§  118.  The  fluctuations  of  the  value  of  gold  commodity 
money. — The  course  of  the  value  of  gold  commodity  money 
from  1789  to  1897  has  been  summarized  by  Irving  Fisher 
as  follows: 

(1)  Between  1789  and  1809  the  exchange  value  of  gold 
against  commodities  in  general  fell  to  just  about  one-half 
of  what  it  was  at  the  beginning  of  the  period. 

(2)  From  1809  to  1849  the  value  of  gold  ascended  to 
about  two  and  one-half  times  what  it  was  at  the  com- 
mencement of  this  period. 

(3)  From  1849  to  1873,  with  two  notable  interruptions, 
gold's  value  fell  to  something  less  than  three-quarters  of 
what  it  was  in  1849. 

(4)  From  1873  to  1897  (a  noteworthy  period  of  falling 
prices  accompanied  by  much  political  agitation  on  money 
questions)  the  value  of  gold  ascended  to  about  one-fourth 
higher  than  in  1873.9 


a  "The    Purchasing   Power    of   Money,"   pp.    240-46.     Fisher    sum- 
marizes the  rise  and  fall  of   prices.     In  our   text  his   figures   have 


STANDARD  MONEY  463 

From  1897  to  1914  there  was  a   great  rise  of  prices. 
According  to  the  index  numbers  of  wholesale  prices  pub-    \t 
lished  by  the  United  States  Bureau  of  Labor,10  amounted 
to  about  50%,  indicating  a  fall  in  the  purchasing  power  of 
gold  to  about  %  of  what  it  was  in  1897. 

§  119.  The  exportability  of  commodity  money. — The  sec- 
ond principal  difference  in  operation  between  the  com- 
modity and  fiat  standards,  lies  in  the  fact  that  com- 
modity money  is  regularly  exportable  as  bullion.  The 
rates  of  exchange  between  two  countries  possessing  the 
same  commodity  standard  are,  by  reason  of  this  fact, 
confined  within  relatively  very  narrow  limits  of  fluctua- 
tion. To-day  the  only  commodity  standard  of  consequence 
which  is  common  to  a  group  of  countries  is  gold.  China 
and  Persia  alone  remain  with  a  silver  commodity  standard. 
As  already  indicated,  the  exchange  rates  in  any  given  gold 
country  upon  any  other  gold  country,  cannot  rise  (in 
the  sense  of  becoming  dearer)  more  than  a  certain  dis- 
tance above  the  mint  par  without  causing  a  gold  export 
which  checks  further  rise.  Likewise  they  cannot  fall  more 
than  a  certain  distance  below  this  point  without  occa- 
sioning a  gold  import,  which  checks  further  fall,  and  in 
normal  times  the  full  range  of  fluctuation  in  the  Ameri- 
can sight  rate  on  England  is,  for  example,  about  1%  of 
the  average  between  the  extremes.11  To  give  but  one  in- 
stance of  the  fluctuation  in  a  rate  of  a  fiat  country  upon 
a  gold  country,  in  the  year  1896  the  rate  in  Rio  Janeiro 
upon  England  varied  from  the  high  point  of  72%2  English 
pence  for  one  Brazilian  milreis  to  the  low  point  of  10%>d. 
per  milreis.  The  range  of  variation  here  amounts  to  22.8% 
of  the  average  of  these  two  rates!     The  fact  has  already 

been  inverted  ho  as  t<>  give  the  fall  or  rise;  in  the  purchasing  power 
of  gold. 

io  Bulletin  of  the  Bureau  of  Labor,  No.  200,  July,  l!)l(i,  p.   13. 

ii  That  is.  in  times  of  peace,  when  both  countries  are  truly  on   the 


4(>4  FOREIGN   EXCHANGE 

boon  mentioned  that  the  Brazilian  government  is  now  tak- 
ing measures  to  confine  the  rate  on  England  within  rela- 
tively narrow  limits,  but  the  example  given  shows  that 
fiat  exchanges  may  do  when  not  controlled.  The  price 
of  exchange  in  one  fiat  country  upon  another  fiat  coun- 
try may  naturally  enough  run  over  a  greater  range  of 
variation  than  that  found  for  any  other  kind  of  exchange. 
The  fundamental  point  is  that  neither  of  such  countries 
can  by  export  convert  its  standard  money  into  that  of 
the  other,  and  the  steadying  influence,  of  such  movements 
as  gold  export  and  import  between  gold  countries,  is  en- 
tirely lacking.  The  fluctuations  of  the  exchanges  between 
a  gold  and  a  silver  country  are  confined  within  certain 
limits  set  by  the  export  and  import  of  specie,  these  limits 
having  the  relative  value  of  gold  and  silver  as  their  approxi- 
mate center.12  Since  the  relative  value  of  gold  and  silver 
is  changeable,  the  limits  which  confine  the  movements  of 
gold-silver  exchanges  are  changeable.  In  the  gold  stand- 
ard countries  the  relative  value  of  gold  and  silver  is  shown 
in  the  price  of  silver.  Especially  during  the  last  forty 
years,  the  price  of  silver  has  been  exceedingly  variable 
in  terms  of  gold  and  the  gold-silver  exchanges  have  shown 
corresponding  instability. 

gold  standard,  and  when  there  is  competition  between  foreign  ex- 
change houses  and  when  banks  are  paying  legal  tender  on  demand. 

12  This  center  corresponds  in  many  respects  to  the  mint  par  of 
the  gold-gold  exchanges,  but  it  is  not  a  mint  par,  and  differs  from 
the  mint  par  in  that  it  is  movable. 


CHAPTER  XVIII 

REPRESENTATIVE  MONEY 

§  120.  The  nominal  and  bullion  values  of  token  moneys. — 
Representative  money  falls  into  the  two  subclasses  of  coin 
and  paper.  The  term  "token  money"  usually  means 
coined  representative  money,  and  is  usually  restricted  to 
this  meaning,  though  occasionally  it  is  extended  to  include 
all  representative  money.  Paper  representative  money  ir 
of  two  kinds,  (1)  the  circulating  promissory  note,  and  (2) 
the  money  certificate.  The  latter,  though  resembling  a 
circulating  demand  note  in  many  essentials,  is  distinguished 
by  the  fact  that  it  can  be  issued  only  against  the  deposit, 
by  the  person  receiving  it,  of  its  full  amount  in  some 
specified  kind  of  money,  and  by  the  fact  that  any  such 
money  must  be  held  as  a  special  trust  fund  to  be  used  solely 
for  the  purpose  of  redeeming  the  certificate,  so  that  the 
outstanding  certificates  are  always  secured  by  a  100% 
reserve.  The  gold  and  silver  certificates,  and  the  former 
"currency"  certificates  of  the  United  States,  and  the 
Philippine  "silver"  certificates  issued  under  the  authority 
of  the  United  States,  are  examples.1  So  far  as  the  writer's 
knowledge  extends,  this  type  of  representative  money  is 
issued  only  by  the  government  of  the  United  States,  but 

i  During  the  lir.st  three  years  of  its  existence  the  Philippine  silver 
certificate  was  exactly  what  its  name  implies,  but  hy  act  of  June  23, 
1906,  Congress  provided  that  gold  coin  of  the  United  Slates  might 
be  used  to  discharge  these  instruments  at  the  rate  of  $1  for  2  pesos 
and  that  such  gold  coin  might  be  substituted  for  silver  in  the  trust 
fund  though  not  to  exceed  G0%  of  this  fund.  The  Philippine  cer- 
tificate is  now  a  gold  and  silver  coin  certificate. 

4G5 


466  FOREIGN  EXCHANGE 

it  should  be  said  the  Bank  of  England  note,  while  not  a 
literal  gold  certificate,  comes  very  close  to  being  one,  so 

that  it  might  be  called  a  virtual  gold  certificate.  (Cf. 
§  129.) 

The  circulating  promissory  note  may  issue  in  a  diversity 
of  ways  either  from  governmental  treasures  or  from  bank- 
ing institutions.  The  reason  for  including  this  instru- 
ment in  the  category  of  money  was  discussed  in  §  2  of 
this  book.  In  present  day  practice  these  notes  are  pay- 
able on  demand  and  do  not  bear  interest.  They  are  se- 
cured by  cash  reserves  and  other  assets  under  the  very 
greatest  variety  of  rules  throughout  the  world. 

In  dealing  with  metallic  representative  moneys,  we  often 
have  occasion  to  distinguish  between  their  nominal  and 
their  bullion  values.  Thus  the  nominal  value  of  the  larg- 
est silver  coin  of  the  United  States  is  $1.00,  and  when 
silver  sells  at  60^  per  fine  ounce  its  bullion  value  is  about 
46^.  Paper  representative  money  has  a  nominal  value 
of  precisely  the  same  nature  as  that  which  belongs  to  token 
coin,  but  it  has  corresponding  to  the  bullion  value  of  the 
latter  only  the  value  of  the  paper  on  which  the  notes  or 
certificates  are  printed,  which  is  wholly  negligible.  Thus 
in  representative  moneys  generally,  we  may  distinguish 
(1)  nominal  value,  and  (2)  material  value,  or  the  value 
of  the  material  of  which  the  money  is  made. 

But  this  class  of  money  possesses  still  another  kind  of 
value  which  makes  itself  distinct  in  times  of  monetary 
derangement.  This  we  may  call  actual  or  circulation  value. 
Suppose  that  a  silver  dollar  were  capable  of  buying  only 
%  as  much  in  trade  as  a  standard  or  gold  dollar  at  a  time 
when  the  price  of  silver  is  65^  per  fine  ounce.  Under  these 
assumptions  this  money  piece  would  have  (1)  a  nominal 
value  of  $1,  (2)  an  actual  value  of  75^  and  (2)  a  material 
or  bullion  value  of  50^.  It  is  the  design  of  the  state  to 
maintain  the  actual  value  of  its  representative  money  at 


REPRESENTATIVE  MONEY  467 

its  nominal  value.  When  its  actual  value  is  held  exactly 
at  its  nominal  value,  a  representative  money  is  said  to  be 
"at  a  parity."  But  when  a  state  fails  to  maintain  such 
money  at  a  parity,  it  does  not  of  necessity  follow  that  its 
actual  value  should  drop  to  the  level  of  its  bullion  or 
material  value.  Were  this  a  necessary  consequence,  the 
moment  paper  money  should  fall  below  par  it  would  have  to 
drop  all  the  way  to  zero !  And  thus  there  is  nothing 
absurd  in  supposing  that  a  silver  dollar  might  have  a  nom- 
inal value  of  $1,  an  actual  value  of  75^,  and  a  third 
or  distinct  value  as  bullion  of  50^.  When  everything  is 
as  it  should  be,  the  nominal  values  and  actual  values  of 
representative  moneys   are   the  same. 

"Nominal"  value  is  an  appropriate  term,  because  the 
value  of  a  piece  of  representative  money  depends  on  the 
words  which  it  bears,  or  on  its  legal  name.  It  is  in  this 
sense  the  value  is  nominal.  This  is  really  no  more  difficult 
to  understand  than  that  the  value  of  a  promissory  note 
depends  upon  the  words  it  contains  and  not  upon  the 
amount  of  the  paper  on  which  it  is  written.  The  value 
of  the  promissory  note  is,  of  course,  nominal  in  precisely 
the  same  sense.  In  fact,  when  representative  money  is 
expressly  redeemable  in  standard  money,  it  amounts  to  a 
promise  or  order  to  pay  the  latter.  When  the  govern- 
ment manages  by  indirect  redemption  rather  than  by  di- 
rect, to  support  its  value,  the  same  thing  remains  virtually 
true. 

It  is  to  be  kept  in  mind  that  all  three  of  the  values  which 
we  have  distinguished  as  belonging  to  representative  moneys 
are  measured  in  standard  money.  When  we  supposed  that 
in  the  United  States  the  silver  dollar  might  have  at  a 
given  time  a  nominal  value  of  100^,  an  actual  value  of  75^, 
and  a  bullion  value  of  50^,  all  three  of  these  figures  signify 
cents  in  gold.  Thus  the  supposition  is  that  though  the 
dollar  is  by  name  designed  to  represent  100^  gold,  it  shows 


468  FOREIGN  EXCHANGE 

a  purchasing  power  in  trade  the  equivalent  of  75^  of  sold, 
while  it  melted  down  into  bullion  the  ingot  which  it  would 
make  would  sell  for  50$  gold. 

§  121.  The  coining  value  and  market  value  of  token 
bullions. — It  is  characteristic  of  metallic  representative 
money  that  its  nominal  (and  thus  normally  what  we  have 
called  its  "actual"  value)  exceeds  its  bullion  value.  Fur- 
thermore its  bullion  value,  in  contrast  with  that  of  "com- 
modity" standard  money,  fluctuates  freely,  because  the 
metals  of  which  representative  moneys  are  made  (silver, 
nickel,  and  copper)  have  variable  market  prices.  This 
brings  us  to  the  distinction  between  the  coining  value  and 
the  market  value  of  token  bullion.  This  distinction  is 
the  same  for  copper  and  nickel  as  it  is  for  silver,  but  we 
need  consider  it  only  in  connection  with  silver.  The 
coining  value  of  silver  is  the  amount  of  silver  coin  which 
can  in  accordance  with  the  legal  definition  of  this  coin, 
be  made  from  an  ounce  (or  other  physical  unit)  of  silver 
bullion.  In  the  United  States  the  coining  value  of  silver 
is  quoted  per  fine  ounce  troy,  and  it  is  $1.2929+,  for  the 
reason  that  one  ounce  of  fine  silver  with  alloy  wTill  make 
l292%oooo+  silver  dollars.  This  figure  is  calculated  as  fol- 
lows: 

The  legal  weight  of  the  silver  dollar  =  412.5  grains  .900  fine. 
The  fine  silver  in  the  dollar  =371%  grains   (412.5  X -900). 
And  if  3711/4  grains  make  one  dollar,  480  grains  (or  1  ounce) 
will  make  480  -r-  371%,  or  1.2929  +  dollars. 

The  coining  value  of  an  ounce  of  fine  gold  is  $20.67+. 
Under  the  right  of  free  coinage  this  also  becomes,  as  we 
have  seen,  the  mint  price  (or  speaking  with  greater  ac- 
curacy, the  mint's  basic  price2)  for  fine  gold.  If  we 
had  free  coinage  of  silver,  $1.29+  would,  of  course,  be- 
come in  the  same  way  the  mint  price  of  silver.     In  point 

2  Cf.  §  109. 


REPRESENTATIVE  MONEY  469 

of  fact,  prior  to  1873  the  United  States  did  have  free 
coinage  of  silver,  and  the  mint  price  of  silver  was  $1.2929-}- 
per  fine  ounce  and  $1.1636-)-  per  "standard"  ounce  .900 
fine.3  But  to-day  silver  is  coined  on  government  account 
only.  The  government  buys  so  much  of  the  metal  as  it 
needs  for  coinage  upon  the  open  market  at  the  fluctuating 
market  price.  The  difference  between  this  price  and  the 
bullion's  coining  value,  constitutes  the  gross  profit  or 
seigniorage  gained  by  the  government  in  the  manufacture 
of  silver  coin. 

Curiously,  silver  has  two  coining  values  in  the  United 

s  From  1792  to  1873  the  United  States  had  a  system  of  legal 
bimetallism.  The  coining  value  of  gold  per  ounce  was  set  at 
(almost)  1G  times  that  of  silver,  giving  the  now  famous  "ratio" 
of  16:1.  It  happened  that  during  a  great  part  of  the  period  from 
1792  to  1873  silver  bullion  had  in  the  open  market  of  the  world 
a  price  in  gold  above  $1.29  per  fine  ounce.  Thus  in  1851  an  ounce 
of  silver  .925  fine  (i.e. — British  "standard"  silver — called  "standard" 
silver  although  since  1817  a  token  bullion  in  England)  sold  in  Lon- 
don for  an  average  price  of  6 Id.  This  price  was  payable  in  gold 
coin  of  England.  If  the  sight  rate  of  New  York  on  London  were  at 
4.86'/^,  a  New  York  dealer  could  ship  silver  from  New  York  to 
London,  sell  it  at  the  rate  of  61d.  per  standard  ounce,  draw  his 
sight  exchange  (payable  in  gold  in  England)  and  realize  $1,337 
less  expenses,  per  fine  ounce  by  the  sale  of  this  exchange  for  gold 
coin  in  New  York.  In  1859  the  London  price  of  silver  rose  to  the 
point  which  gave  a  New  York  equivalent  of  $1.36  per  fine  ounce. 
Thus  the  mint  price  of  $1.29+  failed  to  govern  the  market  price  in 
the  United  States.  There  is  nothing  in  this  contradictory  to  the 
principles  explained  in  §§  108-110  concerning  the  relation  of  the  mint 
price  to  the  market  price  of  standard  bullion  under  free  coinage, 
for  those  principles  apply  only  to  the  case  of  monometallism.  The 
principles  of  bimetallism  (we  might  say,  of  successful  and  unsuc- 
cessful bimetallism)  make  a  subject  so  large  we  cannot  enter  upon 
it,  but  by  way  of  summary  we  may  state  that  under  bimetallic  stat- 
utes the  market  price,  payable  in  local  legal  lender  coin,  of  neither 
standard  metal  can  fall  below  its  mint  price,  although  the  price  of 
either  one  or  the  other  (though  not  of  both  at  once)  may  rise  in- 
definitely above  the  mint  price. 


•17i)  FOREIGN  EXCHANGE 

States.  The  one  heretofore  discussed  is  its  coining  value 
for  the  making  of  silver  dollars.  It  has  a  different  rating 
for  manufacture  into  "subsidiary  silver,"  or  pieces  of 
5(V,  25^,  and  10^,  because  a  dollar's  worth  of  these  coins 
does  not  contain  the  same  weight  of  bullion  as  the  one- 
dollar  piece  of  silver.  The  law  provides  that  two  halves, 
four  quarters,  or  ten  dimes  shall  contain  25  grams  (metric) 
of  silver  .900  fine.  Twenty-five  grams  is  the  weight  of  the 
French  silver  5  franc  piece.  The  United  States  mint  adopts 
385.8  grains  troy  as  the  official  equivalent  of  25  grams, 
and  thus  a  dollar's  worth  of  subsidiary  silver  coins  con- 
tains as  near  as  possible  to  385.8  grains  of  silver  .900  fine. 
The  table  below  is  self-explanatory. 

COINING  VALUE  OF  SILVER  IN  THE  UNITED  STATES 

Gross  Fine  Coining  Value  of  Silver 

Weight  Contents  Per  ounce      Per  ounce 

Grains  Grains  1.000  fine       .900  fine 

The  silver  dollar 412.5  371.25  $1.2929*        $1.1636* 

A  dollar  of  subsidiary 

silver 385.8  347.22  $1,382**        $1,244** 

*  I.e. — coining  value  for  manufacture  into  silver  dollar  pieces. 
**  I.e. — coining  value  for  manufacture  into   subsidiary  silver 
pieces. 

$1.29+  is  the  figure  which  is  commonly  given  as  the  coin- 
ing value  of  silver  in  the  United  States.  But  it  is  in  fact 
the  figure  of  $1.38-)-  which  indicates  the  seigniorage  en- 
joyed by  the  mint  as  manufacturer  of  subsidiary  silver, 
and  at  present  this  is  the  only  form  of  silver  which  our 
mints  coin  regularly.  In  statistics  the  value  of  silver  may 
be  given  either  as  its  "commercial  value"  (price  per  ounce 
in  gold)  or  its  coining  value.  When  the  coining  value 
is  the  one  given  it  is  always  calculated  at  the  rating  of 
$1,294-  per  ounce,  and  not  at  $1,384-.  This  is  because 
the  former  figure  was  once  a  mint  price  of  silver  in  the 


REPRESENTATIVE  MONEY  471 

United  States,  while  the  latter  never  possessed  that  distinc- 
tion. 

In  each  of  the  different  countries  where  silver  is  used  as 
token  money,  it  has  its  particular  local  coining  value,  as 
7.45  francs  per  fine  ounce  in  France,  or  6.22  marks  in 
Germany.4  These  several  coining  values  have  no  relation 
to  the  present  day  market  price  of  silver,  though  all 
have  historical  relations  with  the  former  price  of  silver 
bullion  in  the  days  when  silver  was  a  standard  instead 
of  a  token  money.  This  is  the  place  to  call  to  mind  the 
fact  that  the  comparative  silver  contents  of  the  token 
coins  of  different  countries  have  no  relevancy  to  their 
comparative  values  as  moneys.  For  the  silver  in  the 
mark,  the  franc,  the  shilling,  or  the  dollar,  has,  as  we 
have  seen,  no  bearing  upon  the  normal  money  value  of 
these  pieces. 

§  122.  The  non-exportable  character  of  representative 
moneys. — Under  normal  conditions  a  representative  money 
is  commercially  non-exportable.  In  this  respect  it  is  in 
sharp  contrast  with  commodity  standard  money.  We  can- 
not say  that  a  representative  money  is  absolutely  non- 
exportable,  because  it  is  generally  possible  for  individuals 
to  send  or  take  any  form  of  representative  money  abroad 
and,  if  it  is  in  appreciable  quantities,  to  obtain  for  it 
something  approaching  its  full  nominal  converted  value 
in  foreign  money.  But  when  such  a  money  does  go  abroad, 
the  only  economical  use  to  which  it  can  be  put  by  the 
dealer  who  gives  foreign  money  for  it,  is  to  send  it  back  to 
its  home  country.  Thus  as  we  may  express  it,  represen- 
tative money  is  not  finally  exportable.  And  for  the  very 
reason  that  when  it  is  sent  away  from  home,  some  one 
must  bear  the  expense  of  sending  it  back,  it  can  rarely  be 
employed  commercially  as  a  means  of  remittance.     In  any 

*  Converted  from  the  metric  system  in  which  the  French  and  Ger- 
man money  units  are  legally  defined. 


172  FOKEIUX  EXCIIAXGE 

event  it  is  clear  it  cannot  be  used  as  a  final  means  of  dis- 
charging: a  national  balance  of  indebtedness.  Thus,  when 
it  comes  to  pass  that  the  United  States,5  having  become 
indebted  abroad  in  a  greater  sum  than  its  credits  against 
foreign  places,  needs  to  export  say  $1,000,000  of  money 
on  balance,  if  gold  is  sent  it  may  be  converted  into  foreign 
standard  money  and  thus  finally  liquidate  the  indebtedness. 
But  if  $1,000,000  of  United  States  Notes  or  gold  certifi- 
cates should  be  sent,  since  they  could  neither  enter  directly 
into  circulation  abroad  nor  be  manufactured  over  into 
foreign  money,  they  would  merely  come  back  home  and 
only  by  paying  for  them  in  something  that  can  stay  abroad 
could  the  United  States  permanently  liquidate  its  bal- 
ance of  indebtedness. 

The  Bank  of  England  note  is  preeminent  among  repre- 
sentative moneys  for  having  a  general  acceptability  in  parts 
of  the  world  foreign  to  the  home  country.  Just  as  New 
York  exchange  is  readily  salable  in  almost  any  part  of  the 
United  States,  so  London  exchange  has  a  good  market  in  al- 
most any  part  of  the  civilized  world.  The  Bank  of  Eng- 
land note  is,  of  course,  a  very  superior  form  of  sight  sterling 
exchange.  In  large  lots,  these  notes  could  naturally  be 
sold  for  the  very  highest  exchange  prices.  In  small  quan- 
tities thej*  bring  a  reasonable  price  in  any  commercial 
capital  of  the  world.  Without  taking  the  trouble  to  make 
a  statistical  study  of  the  average  price  of  foreign  bank 
notes  in  relation  to  the  rates  for  bankers'  sight  drafts, 
we  may  give  the  following  quotations  for  a  single  day  as 
being  of  interest.  The  prices  given  for  bank  notes  are 
those  offered  in  New  York  on  February  17,  1912,  by 
Zimmerman  and  Forshay  for  such  currency  in  small 
lots. 

5  Meaning,  of  course,  simply  the  entire  group  of  persons  in  the 
United  States  who  have  entered  into  business  engagements  with  for- 
eigner?. 


REPRESENTATIVE  MONEY  473 

PRICE  OF  FOREIGN  MONEY  ON  DIRECT  SALE  IN 
NEW  YORK 


(1) 

(2) 

(3) 

This  con- 

(4) 

N.  Y.  Rate 

verted  to 

Percent- 

Price 

for  Bank- 

dollars per 

age 

of  Bank 

ers'  Sight 

1  foreign 

which  (1) 

Notes 

Drafts 

unit 

is  of  (3) 

Bank  of  England  notes,  per  £ $4,865 

4.8725 

4.8725 

99.8% 

Notes     of    Bank     of    France     per 

franc     1925 

5.18%  less  Vie 

.1929 

99.7% 

Notes   of   Reichsbank,    per   mark..     .2370 

■95Ve 

.2378 

99.67o 

On  the  same  date  this  firm  offered  95<?  for  the  French  5  franc 
piece  of  silver  (i.e.,  at  the  rate  of  19?  per  franc)  and  $4.84  per  £ 
for  English  silver  coin.  The  following  quotations  also  may  be 
noted:  gold  sovereigns,  $4,865;  gold  20  mark  pieces,  $4.74  ($.237 
per  mark) ;  gold  20  franc  pieces,  $3,875  ($.19375  per  franc). 

In  the  Paris  market,  Jan.  27,  1912,  Bank  of  England  notes 
were  quoted  at  25.24  @  25.26  francs  per  £,  when  sight  exchange 
was  25.25  @  25.28. 

The  New  York  house  purchasing  these  foreign  moneys 
must  as  a  regular  thing  realize  upon  them  by  the  simple 
expedient  of  using  them  as  a  substitute  for  exchange, 
namely  by  remitting  them  abroad  and  selling  drafts 
against  the  proceeds. 

To  summarize:  a  commodity  standard  money  (in  a  word, 
gold  money)  is  exportable  and  importable  as  a  part  of 
the  regular  course  of  things.  Representative  moneys  of 
paper  can  never  be,  as  we  chose  to  express  it,  the  subjects 
or  final  export.  Representative  moneys  of  metal  come  un- 
der the  same  rule,  unless  the  foreign  market  price  of  the 
bullion  of  which  they  are  composed  should  rise  so  high  that 
export  would  become  profitable.  Such  a  contingency  would 
have  to  be  met  by  the  reduction  of  the  bullion  contents 
of  the   representative   money   by   the   home   government.6 

o  Compare  §123.  If  the  price  of  silver  should  pass  above  59d. 
in  London  (the  quotation  being  per  <>/..  British  standard  silver, 
that  is,  silver  .925  fine)   it  would  pay  commercially  to  export  United 


171  FOREIGN  EXCHANGE 

But  even  if  this  action  were  not  taken,  the  export  possi- 
bilities of  the  representative  money  would  by  no  means 
make  it  a  substitute  for  the  regular  standard  money  as  a 
means  of  adjustment  of  international  balances.  In  the 
first  place,  it  would  probably  have  a  strong  tendency  to  flow 
in  one  direction  only,  and  in  the  second  place,  its  avail- 
ability for  export  would  depend  upon  the  position  of  the 
fluctuating  price  of  the  bullion  of  which  it  is  made.  The 
conclusion  is  that  it  is  no  part  of  the  regular  function  of 
representative  moneys  to  serve  as  articles  of  export  and 
import,  and  as  means  of  discharging  international  balances 
of  indebtedness. 

§  123.  The  features  of  a  perfected  system  of  token  money. 
— Xot  all  countries  have  brought  the  administration  of 
their  token  moneys  into  entire  conformity  with  correct 
principles,  but  the  drift  of  modern  practice  makes  unmis- 
takable what  the  requirements  are  of  a  perfected  system 
of  token  money.  The  four  essentials  about  to  be  indi- 
cated are  those  given  by  Professor  J.  L.  Laughlin  in  his 
"Principles  of  Money."7 

(1)  Token  money  may  be  coined  only  on  government 
account.  (We  hardly  need  pause  to  show  that  a  system 
of  free  coinage  of  token  money  with  a  variable  seigniorage 
would  be  impracticable.) 

(2)  Token  coin  must  be  made  with  a  bullion  content 
sufficiently  small  to  preclude  the  possibility  of  its  being 

States  silver  dollars  to  be  sold  on  the  London  market  as  bullion. 
Though  silver  was  often  above  this  price  in  the  middle  of  the  nine- 
teenth century,  it  has  not  reached  such  a  height  since.  The  sale  of 
the  silver  would  be  for  gold  money  of  England,  against  which  ster- 
ling exchange  would  be  drawn  and  sold  in  New  York  for  American 
money.  At  a  price  of  59d.  per  oz.,  more  than  a  dollar  of  U.  S. 
legal  tender  would  thus  be  realized  on  every  silver  dollar  shipped 
abroad,  it  being  assumed  that  sterling  exchange  stands  at  par 
(4.8665)  in  New  York. 
7  Chapter  XV. 


REPRESENTATIVE  MONEYS  475 

melted  down  for  sale  as  metal  at  home  or  abroad.  Some 
of  the  noteworthy  tokens  of  the  leading  nations  were  once 
standard  money,  and  retained  the  weight  and  fineness  they 
had  in  the  days  of  their  higher  standing.  But  since  the 
pronounced  fall  in  the  price  of  silver  which  began  in  1872, 
none  of  them  has  been  in  great  danger  of  the  melting  pot. 
Still  the  war-time  ascent  of  the  white  metal  to  a  dollar  a 
fine  ounce  brings  the  bullion  value  of  the  silver  dollar  of 
the  United  States  up  to  77^.  Beneath  are  some  statis- 
tics for  this  country. 


Average  Price 


Selected  Years 

fine  ounce) 

1872 

$1.32 

1875 

1.24 

1885 

1.06 

1895 

.65 

1905 

.61 

1909 

.52 

1910 

.54 

March  1919 

1.01 

Bullion  Value 

lion  Value 

of  a  Dollar 

J.  S.  Silver 

of  Subsidiary 

Dollar 

Silver  * 

1.022 

$  .954 

.96 

.896 

.82 

.766 

.50 

.47 

.47 

.44 

.40 

.376 

.418 

.39 

.78 

.73 

*  As  two  half-dollars,  four  "quarters,"  or  ten  dimes. 

(3)  A  token  money  ought  to  be  directly  redeemable 
at  its  nominal  value  in  standard  money  on  demand.  Like- 
wise all  forms  of  token  money  should  be  issuable  on  de- 
mand to  any  applicant  who  offers  standard  money  in  ex- 
change. The  method  of  direct  redemption  is  the  simplest 
and  most  certain  for  supporting  parities.  It  provides 
automatically  for  the  maintenance  of  the  proper  quantity 
of  token  moneys  in  circulation,  for  the  supply  of  a  de- 
ficiency or  the  withdrawal  of  a  surplus.  The  government 
needs  only  to  manufacture  enough  tokens  to  keep  its  ex- 
change offices  in  a  position  to  meet  the  demands  made  upon 
them  by  the  general   public.     It   is  true,  as  historical  evi- 


476  FOREIGN   EXCHANGE 

deuce  shows,  that  a  sufficient  limitation  placed  upon  the 
supply  of  tokens,  which  have  once  been  established  in  com- 
merce, will  sustain  their  parity  without  the  express  legal 
right  of  redemption  at  government  offices  on  demand. 
Furthermore,  if  a  government  receives  its  tokens  freely  in 
payments  due  it,  and  pays  out  standard  mone}'  freely  on 
request  in  payments  due  its  creditors,  this  furnishes  a  kind 
of  indirect  redemption  which  unaided  may  serve  in  prac- 
tice to  sustain  parity.8  But  the  method  of  direct  redemp- 
tion is  the  only  clear-cut  and  entirely  safe  method  of  man- 
aging the  token  (and  also  other  representative)  elements 
in  the  circulation. 

(4)  In  the  fourth  place  token  moneys  or  some  of  them 
should  be  given  a  limited  legal  tender  power  to  enable  the 
technical  legal  discharge  of  debts  involving  fractional  sums 
— such  as  a  debt  for  $7.83.  One  reason  for  restricting 
their  legal  tender  power  to  small  amounts  in  a  single  pay- 
ment is  to  prevent  their  employment  by  a  spiteful  debtor 
to  pay  off  a  large  account  with  a  great  weight  and  bulk 
of  metal.  Another  is  the  negative  reason  that  there  is  no 
necessity  for  money  serving  as  change  to  be  legal  tender 
in  large  sums.  Again  in  case  a  token  money  should  lose 
its  parity  it  would  be  inecniitable  if  any  substantial  debt 
should  be  dischargeable  in  it. 

§124.  The  limping  gold  standard. — The  "limping  gold 
standard"  (French  "etalon  boiteux")  is  a  term  of  fairly 
recent  origin  applied  to  the  monetary  system  of  a  country 

s  The  history  of  the  American  silver  dollar  since  1878  is  espe- 
cially instructive  in  this  connection.  It  has  been  maintained  at  a 
parity  by  the  method  of  indirect  redemption.  This  method  works 
provided  the  government  does  not  manufacture  and,  through  its  ex- 
penditures, discharge  into  circulation  too  great  a  quantity  of  tokens. 
See  A.  D.  Noyes,  "Forty  Years  of  American  Finance,"  or  J.  L. 
Laughlin,  "History  of  Bimetallism  in  the  United  States,"  (appro- 
priate chapters).  Not  even  to-day  does  the  silver  dollar  of  the 
United  States  have  the  legal  right  of  redemption  in  gold. 


REPRESENTATIVE  MONEY  477 

which  has  associated  with  a  gold  standard  money,  token 
currency  possessing  unlimited  legal  tender  power  without 
being  by  express  declaration  of  law  redeemable  in  gold. 
France  and  the  United  States  have  been  on  this  standard 
since  1873.  Germany  was  on  it  from  1871  until  1907  in 
which  year  a  law  was  passed  (October  1)  taking  the  legal 
tender  power  away  from  the  silver  thaler  (or  piece  of  three 
marks).  The  limping  standard  arose  out  of  the  suspension 
of  the  free  coinage  of  silver  by  the  three  countries  named 
(in  1871  by  Germany,  and  in  1873  by  France  and  the 
United  States)  without  the  removal,  from  the  formerly 
standard  silver  coins,  of  their  earlier  attributes  of  irre- 
deemability  and  full  legal  tender  power.  The  essential 
point  in  the  monetary  system  thus  developed  which  has 
earned  for  it  the  appellation,  "limping"  standard,  is  that 
in  the  strict  letter  of  the  law  contracts  for  money,  includ- 
ing bank  deposits  and  commercial  paper,  can  be  discharged 
in  silver  coin,  and  the  government  is  not  explicitly  bound 
to  redeem  this  coin  in  gold.  Hence  Englishmen,  for  in- 
stance, living  in  a  country  which  had  before  the  war  a 
standard  without  a  limp,  a  fact  of  which  they  were  well 
aware,  were  inclined  to  say  a  person  could  not  be  sure 
that  credit  claims  in  France  or  the  United  States  are 
just  as  good  as  gold.  The  French  silver  five-franc  piece 
and  the  United  States  silver  dollar  are  the  coins  which 
possess  full  tender  power  without  explicit  legal  authority 
for  redemption  in  standard  gold  money.  France  alone 
utilizes  the  possibilities  contained  in  the  limping  standard 
for  hampering  gold  export.0  In  the  United  States 
absolutely  no  use  in  made  of  these  possibilities.  And  de- 
spite the  tradition  dominating  all  London  "financial" 
writers,  New  York  has  been  for  years  the  freest  gold  market 
in  the  world — when  New  York  banks  have  not   suspended 

b Bee  Chapter  XX,  §  140,  on  the  gold  premium  policy  of  the  Bank 
of  Frame. 


FOREIGN    EXCHANGE 

payments  for  a  period.  Their  occasional  suspensions  have 
had  nothing  to  do  with  the  limping  standard  in  the  United 
States. 

While  from  1890  to  1896  there  was  much  fear  at  home 
and  abroad  lest  our  silver  dollar  should  lose  its  parity 
with  gold,  this  event  has  never  happened.  Still  the  only 
legal  protection  existing  for  the  parity  of  this  coin  is  the 
statutory  declaration  (see  §  1,  Act  of  March  14,  1900) 
that  it  is  the  policy  of  the  United  States  to  maintain  all 
forms  of  money  at  parity  with  gold  and  that  it  shall  be 
the  duty  of  the  Secretary  of  the  Treasury  to  maintain  these 
parities.  It  seems  at  present  writing  quite  out  of  the  ques- 
tion to  develop  any  great  alarm  about  the  limp  in  the 
American  gold  standard.  As  already  explained  (§  3),  con- 
tracts calling  specifically  for  gold  cannot  be  discharged  in 
silver  or  paper  money  in  the  United  States  except  by 
consent  of  the  creditor.  A  bank  deposit,  however,  is  a 
contract  for  plain  "dollars"  and  not  specifically  for  gold 
coin,  and  is  therefore  dischargeable  in  U.  S.  Treasury  Notes 
and  silver  dollars  as  well  as  in  gold. 


CHAPTER  XIX 

MONETARY  SYSTEMS  OF  THE  LEADING  NATIONS 

§  125.  Troy  and  metric  weight. — The  legal  specifications 
of  the  "standard  unit  of  value"  are  laid  down  in  troy 
weight  in  the  United  States  and  England,  and  in  metric 
weight  in  France  and  Germany  and  the  majority  of  other 
gold  standard  countries.  According  to  the  received  histori- 
cal account,  the  original  troy  pound  was  the  weight  of  7,680 
grains  of  wheat,  all  taken  from  the  middle  of  the  ears  and 
well  dried.  But  the  unit  of  weight  known  to-day  as  the 
troy  pound  is,  in  the  United  States,  simply  the  weight  of 
a  certain  piece  of  brass  kept  by  the  Philadelphia  mint. 
Whatever  balances  exactly  against  this  in  the  scales  has 
a  weight  of  one  troy  pound.  This  brass  weight-unit  is 
itself  a  copy,  procured  in  1827  by  the  minister  of  the  United 
States,  of  a  certain  piece  of  brass  formerly  kept  by  the 
English  government  as  its  official  troy  pound.  The  pres- 
ent standard  of  weight  in  England  is  a  certain  block  of 
platinum  called  the  British  imperial  pound.  This  is  the 
legal  avoirdupois  pound,  and  in  England  an  official  troy 
pound  weight  does  not  exist.  Legally  a  troy  pound  is 
any  weight  B76%ooo  or  luA~r,  as  great  as  the  imperial  pound. 
In  the  destruction  of  the  Houses  of  Parliament  a  number 
of  older  British  standards  of  measurement  were  destroyed 
or  made  useless  and  a  new  se1  was  prepared. 

The  unit  of  weight  under  the  metric  system  is  the  kilo- 
gram. This  is  the  weight  of  a  certain  block  of  platinum 
and  iridium  kept  by  the  International  Bureau  of  Weights 
and  Measures  near  Paris.     This  block   was  established   as 

479 


ISO  FOREIGN  EXCHANGE 

Hie  standard  metric  kilogram  weight  by  the  concurrent 
action  of  the  chief  governments  of  the  world.  Although 
the  kilogram  was  in  the  first  instance  derived  from  the 
meter,  or  metrical  unit  of  length,1  the  ultimate  scientific 
definition  of  the  kilogram  is  now  simply  the  weight  of 
this  particular  official  block  of  metal.  Between  the  troy 
pound  and  the  kilogram,  there  is  no  ratio  depending  upon 
mathematical  or  physical  law.  From  the  standpoint  of 
physical  science  the  two  units  of  weight  are  simply  two 
arbitrarily  selected  blocks  of  metal,  and  the  ratio  between 
them  can  be  obtained  only  by  actual  weighing  of  one  against 
the  other  in  the  balance.  According  to  the  appraisal 
adopted  by  the  Bank  of  England  and  by  the  United  States 
mints,  the  kilogram  has  a  troy  equivalent  of  15,432  grains 
(or  2  lbs.  8  oz.  3  dwt.).2  Comparative  weighing  of  the 
two  standards  has,  however,  been  carried  out  to  further 
decimals,  giving  such  results  as 

1  kilogram  =  15,432.349  grains,  or  again, 
1  kilogram  =  15,432.35639  grains. 

The  tables  following  show  the  fractions  of  units  in  the 
troy  and  metric  systems  of  weight. 

i  The  one-hundredth  part  of  the  meter  is  the  centimeter.  The 
gram  (the  original  unit  of  weight,  but  now  merely  the  one-thou- 
sandth part  of  the  official  kilogram)  was  first  defined  as  the  weight 
of  1  cubic  centimeter  of  water  at  its  maximum  density  under  a 
pressure  of  one  atmosphere. 

2  In  connection  with  its  bullion  dealings,  the  Bank  of  England 
converts  kilograms  into  troy  weight  at  this  rate.  Tate's  "Modern 
Cambist,"  24th  ed.,  1908,  by  H.  T.  Easton,  p.  59,  note.  For  the 
purpose  of  translating  the  legal  metric  definition  of  United  States 
subsidiary  silver  coin  (see  §  121,  p.  470)  into  troy,  the  mints  of  this 
country  have  adopted  15.432  grains  as  the  equivalent  of  a  gram  (the 
same  ratio  as  15,432  grains  equal  to  one  kilogram).  The  mint  ac- 
tually manufactures  the  subsidiary  silver  pieces  in  accordance  with 
their  translated  troy  weights.  See  "Instructions  and  Regulations 
for  Mints  and  Assay  Offices,"  1908,  Treas.  Department  Doc.  No.  2,494. 


MONETARY  SYSTEMS  OF  LEADING  NATIONS      481 

Troy 

Abbreviations :    lb.  =  pound,    oz.  =  ounce,    dwt.  =  pennyweight, 
and  gr.  =  grain. 

1  lb.  =  12  oz.  ==  240  dwts.  =  5,760  grains. 

1  oz.  =    20  dwts.  =     480  grains. 

1  dwt.    =       24  grains. 

Metric 

1  kilogram  =  10  hectograms  =  100  decagrams  =  1,000  grams. 

1        gram  =  10  decigrams    =  100  centigrams  =  1,000  milligrams. 

Approximate  Equivalents 

1  kilogram  =  2.2  lbs.  avoirdupois  =  2.67  lbs.  troy. 
1      lb.     avoirdupois  =  1.21  lbs.  troy.3 
Official  ratio  in  England  and  the  United  States, 
1  kilogram  =  15,432  grains. 

§  126.  The  standard  units  of  value. — 

United  States 

A  statute  of  the  United  States  of  March  14,  1900,  de- 
clares (§1) 

That  the  dollar  consisting  of  twenty-five  and  eight-tenths  grains 
of  gold  nine-tenths  fine  *  *  *  shall  be  the  standard  unit  of  value, 
and  all  forms  of  money  issued  or  coined  by  the  United  States  shall 
be  maintained  at  a  parity  of  value  with  this  standard,  and  it  shall 
be  the  duty  of  the  Secretary  of  the  Treasury  to  maintain  such 
parity. 

The  statement  that  the  dollar  of  25.8  grains  shall  be  the 
standard  unit  of  value,  means  that  such  gold  coins  as  are 
Struck  shall  contain  this  number  of  grains  per  dollar  of 
their  nominal  or  legal-tender  value,  and  does  not  necessarily 

3  Troy  and  avoirdupois  are  not  independent  systems,  as  are  troy 
and  metric,  or  avoirdupois  and  metric.  1  lb.  troy  =  5,760  grains, 
and  1  lb.  avoirdupois  =  7,000  of  the  same  grains,  and  therefore  144 
lbs.  avoirdupois  equals  exactly   17.r>  lbs.  troy. 


482  FOREIGN  EXCHANGE 

signify  thai  a  one-dollar  piece  of  gold  shall  actually  be 
coined,  hi  l'acl  the  one-dollar  gold  piece  was  first  author- 
ized in  1849  and  discontinued  in  1890.  The  statutor}r  his- 
tory of  the  gold  contents  of  the  standard  unit  is  as  follows: 

Weight  of  the  1'nited  States  Gold  Dollar  (not  always  coined) 


Gross 

Fine- 

Fine 

Weight 

ness 

Contents 

Act  of  April  2, 

1792. . 

27      grains 

.916% 

24.75  grains 

Act  of  June  28, 

1834.. 

25.8  grains 

.899225 

23.2     grains 

Act  of  Jan.  18, 

1837.. 

25.8  grains 

.900 

23.22  grains 

Present  metric  weight  of  the  dollar  1.6718  grams  (gross), 
1.5046  grams  (fine). 

The  Act  of  Feb.  12,  1873,  dropped  the  silver  dollar  from 
the  list  of  coins  of  the  United  States.  The  silver  dollar 
was  theretofore  legally  a  standard  coin,  coordinate  in  this 
respect  with  the  gold  money  of  the  country,  and  before 
1873  the  United  States  possessed  a  system  of  legal  though 
not  of  actual  bimetallism.  In  a  somewhat  uncertain  man- 
ner, the  act  of  1873  put  the  country  upon  a  basis  of  legal 
gold  monometallism,  with  the  same  gold  dollar  as  that  pro- 
vided by  the  act  of  1837.  It  remained  for  the  act  of  1900 
to  make  the  adoption  of  the  gold  standard  definitive.4 

Great  Britain 

The  pound  sterling  of  England  is  a  unit  of  12317%23  (or 
123.27447)  grains  troy  of  gold  %s  fine,  with  a  pure  con- 
tents of  113%23  grains. 

*  This  would  seem  to  be  a  fair  description  of  the  effect  of  the  act 
of  1900,  in  spite  of  the  fact  that  it  could  have  been  made  stronger 
if  sections  had  been  inserted  providing  expressly  for  the  redemption 
in  gold  of  all  forms  of  representative  money,  including  the  silver 
dollar,  and  providing  that  this  dollar  should  have  only  those  legal 
tender  powers  which  are  given  the  "subsidiary"  silver.  The  Sec- 
retary of  the  Treasury  is  charged  with  the  duty  of  maintaining  the 


MONETARY  SYSTEMS  OF  LEADING  NATIONS      483 
The  English  money  notation  is  shown  below. 

1  pound  =  20  shillings  =  240  pence  =  960  farthings. 

1  shilling   =    12  pence  =    48  farthings. 

1  penny  =      4  farthings. 

A  sum  of  English  money  is  commonly  written  in  figures  in  the 
following  fashion:  £3.  17s.  9d.  or  £3.  17/9  (i.e.,  three  pounds, 
seventeen  shillings,  and  nine  pence,  a  sum  which  happens  to  be  the 
Bank  of  England's  legal  minimum  buying  price  for  gold). 
£,  s,  and  d,  are  abbreviations  for  the  Latin  words,  libra,  solidus, 
and  denarius.     Shillings  may  also  be  abbreviated  as  "sh." 

France 

The  standard  unit  of  value  of  France  is  the  franc  with 
a  contents  of  0.32258  grams  of  gold  .900  fine.  A  number 
of  countries  in  different  parts  of  the  world  have  adopted 
laws  providing  standard  units  of  gold  with  the  same  weight 
and  fineness  as  the  French  franc.  But  not  all  these  coun- 
tries have  been  so  fortunate  as  to  possess  a  gold  standard 
in  point  of  fact.     A  list  follows. 

Countries  with  the  Same  Legal  Gold  Unit  as  France 

Name  And  its  one- 

I  Of  Unit  hundredth  part 

Members  of  the 
Latin  Monetary  Union 

France    franc  centime 

Belgium   franc   centime 

Switzerland franc   centime 

Italy   lire    centesimi 

Greece    drachma    lepta 

parity  of  all  representative  moneys,  but  this  is  not  quite  the  equiva- 
lent of  such  a  provision  as  the  one  just  mentioned.  That  is,  the 
act  might  have  taken  the  country  off  the  "limping  gold  standard." 
See  §  124. 


FOREIGN   KXCIIANGE 

Countries  with  fix   Sarin   Legal  Gold  Unit  as  France 
(Continued) 

Name  And  its  one- 

II  Of  Unit  hundredth  part 

Other  Countries 

Spain    peseta    centimo 

Finland    mark    penni 

Bulgaria leva    statinki 

Servia dinar   paras 

Venezuela    bolivar    centimes 

Argentine  Republic . .  1  peso  of  100  centavos  has  exact  gold 

contents  of  5  francs  (i.e.,  1.6129  grams 

.900  fine). 


Germany 

The  standard  unit  of  value  of  the  German  Empire  was 
established  by  the  law  of  December  -1,  1871,  which  provides 
that  "there  shall  be  coined  an  Imperial  gold  piece,  of 
which  139^  shall  be  made  from  one  pound  of  fine 
gold.  The  tenth  part  of  this  piece  shall  be  known  as 
the  mark  and  shall  be  divided  into  100  pfennigs.  .  .  . 
The  composition  of  imperial  gold  coin  shall  be  900 
thousandths  of  gold  and  100  thousandths  of  copper. 
Accordingly  125.55  ten-mark  pieces  shall  weigh  one 
pound.  ..."  The  German  pound  (pfund)  is  exactly 
500  grams  or  one-half  kilogram.  Consequently  279  (i.e., 
2  times  139a->)  pieces  of  ten-marks,  or  2,790  marks  are 
coined  from  one  kilogram  of  fine  gold.  This  gives  the 
mark  the  following  weight: 

Gross  "Weight  Fineness  Fine  Contents 

Mark  (gold)    398274  grams  .900  .358422  grams 


MONETARY  SYSTEMS  OF  LEADING  NATIONS      485 

The  Germans  use  a  comma  where  we  use  a  decimal  point. 
Thus  the  sum  written  by  us  as  2505.32  marks  appears  in 
German  as  2505,32  marks. 

§  127.  Tables  of  mint  pars. — The  chief  mint  pars  of  the 
world  are  indicated  in  the  tables  beneath. 


MINT  PARS  OF  THE  UNITED  STATES 

One  Foreign  Unit  One  U.  S.  Dollar 

Dollars  as  below  equals   Foreign 

equals  U.  S.  Units  as  below 

England pound  $4.86656  49.316     pence* 

France  f franc  .19295  5.1826  francs 

Germany    mark  .23821  4.1979  marks 

Netherlands florin  §  .40195  2.4878  florins 

Austria crown  .20262  4.9351  crowns 

Russia ruble  .51456  1.9433  rubles 

Japan yen  .49845  2.0061  yens 

*  Or  $1  equals  £.20504  -f. 

f  The  figures  are  also  good  for  the  franc  of  Belgium  and 
Switzerland,  lire  of  Italy,  drachma  of  Greece  (not  in  circulation 
and  at  a  premium),  peseta  of  Spain,  mark  of  Finland,  lei  of  Ron- 
mania,  and  certain  other  coin  with  the  same  definition  as  the 
French  franc. 

§  The  florin  is  also  called  the  "guilder"  and  the  "gulden." 

MINT  PARS  OF  GREAT  BRITAIN 

One  Foreign  Unit       One  English  Pound 
Equals  English  Equals    Foreign 

Pence  as  below  Units  as  below 

United  States   dollar  49.316  d.         4.8665  dollars 

France    franc  9.5157d.  25.22155  francs 

Germany    mark  11.7477d.  20.429 155  marks 

Netherlands florin  19.823Dd.  12.1071186  florins 

Austria     crown  9.9927d.  24.017427  crowns 

Russia    ruble  25.3764d.         9,157582  rubles 

Japan    yen  24.5819d.         8.763278  yens 


tsei 


FOREIGN  EXCHANGE 


MINT  PARS  OF  FRANCE 

One   Foreign  One  Franc 

Unit  Equals  Equals  Foreign 

Francs  as  below  Units  as  below 

United  States  dollar        5.1826  f.  0.192952  dollars 

England pound     25.22155f.  9.5157      pence 

Germany    mark         1.23456f.  0.81           marks 

Netherlands florin         2.0832  f .  0.48003     florins 

Austria crown        1.0501  f.  0.9522       crowns 

Russia ruble         2.6668  f.  0.3749       rubles 

Japan yen            2.5833  f .  0.3871      yens 

Other  countries  possessing  the  same  gold  unit  at  law  as  France 
are  listed  on  page  483. 

MINT  PARS  OF  GERMANY 

One  Foreign  One  Mark 

Unit  Equals  Equals  Foreign 

Marks  as  below  Units  as  below 

United  States  dollar       4.19792M  0.23821  dollars 

England   pound     20.42945M  11.74774  pence 

France    franc        0.81       M  1.23456  francs 

Netherlands florin        1.68739M  0.59263  florins 

Austria crown       0.85061M  1.17562  crowns 

Russia ruble        2.16011M  0.46293  rubles 

Japan yen           2.09247M  0.47790  yens 


The  mark  is  to  the  franc  exactly  as  100  to  81. 

The  data  for  the  tables  of  this  section  may  be  found  in  the  Re- 
port of  the  Commission  on  International  Exchange  (U.  S.)  on 
The  Gold  Standard  in  International  Trade  (1904),  page  512. 


MONETARY  SYSTEMS  OF  LEADING  NATIONS      487 

§  128.  Technical  detail.     The  United  States. — 

THE  COINS  OF  THE  UNITED  STATES 
(at  present  authorized  to  be  struck,  1919) 

Gold 

Gross  Fine  Fine 

Nominal     "Weight  Fine-  Contents     Contents 

Name            Value       (grains)  ness  (grains)       (grams) 

Double-eagle    ..  $20           516  .900  464.4            30.0926 

Eagle  10           258  .900  232.2            15.0463 

Half-eagle    ....       5            129  .900  116.1               7.5231 

Quarter-eagle  ..       2.50        64.5  .900  58.05            3.7615 

Silver 

Half-dollar 50       192.9  .900  173.61 

Quarter-dollar    .         .25         96.45  .900  86.805 

Dime 10        38.58  .900  34.722 

Nickel 

"Nickel" 05        77.16    75%  copper,  25%  nickel. 

Bronze 
Cent 01        48         95%  copper,  5%  tin  and  zinc. 

The  Silver  Dollar 
Dollar  1.00      412.5  .900        371.25  grains. 

Legal  tender  in  the  United  States. — In  the  discussion 
of  the  general  nature  of  legal  tender  given  in  §  3,  we  drew 
our  illustrations  from  the  legal  tender  law  of  the  United 
States,  and  we  need  add  little  to  the  latter  subject  in  the 
present  section.  The  several  forms  of  money  in  circula- 
tion in  the  United  States  possess  a  variety  of  special  tender 
powers,  which  are  explained  brie%  in  the  quotation  below. 

"Gold  coin  is  legal  tender  at  its  nominal  or  face  value  for  all 
debts,  public  and  private,  when  not  below  the  standard  weight 
and  limit  of  tolerance  prescribed  by  law;  and  when  below  such 

standard  and  limit  of  tolerance  it  is  legal  tender  in  proportion  to 
its  weight. 

"Standard'  silver  dollars  are  legal  fender  al  their  nominal  or 
face  value   in   payment   of  all   debls,  public  and   privale,   without 


FOKEIGN  EXCHANGE 

regard  to  the  amount,  except  where  otherwise  expressly  stipulated 
in  the  contract. 

"Subsidiary  silver  is  legal  tender  for  amounts  not  exceeding 

#10  in  any  one  payment. 

'•  I  r<  asury  notes  of  the  Act  of  July  11,  1890,  are  legal  tender  for 
all  debts,  public  and  private,  except  where  otherwise  expressly 
stipulated  in  the  contract. 

"United  States  notes  are  legal  tender  for  all  debts,  public  and 
private,  except  duties  on  imports  and  interest  on  the  public  debt. 
United  States  notes,  upon  resumption  of  specie  payments,  Janu- 
ary 1,  1879,  became  acceptable  in  payment  of  duties  on  imports 
and  have  been  freely  received  on  that  account  since  the  above  date, 
but  the  law  has  not  been  changed. 

"Gold  certificates,  silver  certificates,  and  national-bank  notes 
are  not  legal  tender,  but  both  classes  of  certificates  are  receivable 
for  all  public  dues,  while  national-bank  notes  are  receivable  for 
public  dues  except  duties  on  imports,  and  may  be  paid  out  by 
the  Government  for  all  salaries  and  other  debts  and  demands 
owing  by  the  United  States  to  individuals,  corporations,  and  asso- 
ciations within  the  United  States,  except  interest  on  the  public 
debt  and  in  redemption  of  the  national  currency.  All  national 
banks  are  required  by  law  to  receive  the  notes  of  other  national 
banks  at  par. 

"The  minor  coins  of  nickel  and  copper  are  legal  tender  to  the 
extent  of  25  cents."  5 

Federal  Reserve  Bank  Notes  have  the  same  special  tender 
powers  as  National  Bank  Notes,  it  being  added  that  Federal 
Reserve  Banks  are  required  to  receive  them  in  payment  at 
par  (this  under  the  statutory  provision  that  they  shall  be 
to  the  "same  tenor  and  effect  as  national-bank  notes,"  §  18, 
Federal  Reserve  Act  of  Dec.  23,  1913). 

Federal  Reserve  Notes  "shall  be  receivable  by  all  na- 
tional and  member  banks  [i.e.,  members  of  the  Federal 
Reserve  banking  system]    and  Federal  reserve  banks  and 

5  From  United  States  Treasury  Department  Circular,  No.  62,  '"In- 
formation Respecting  United  States  Bonds,  Paper  Currency,"  etc., 
July  1,  1908,  p.  15. 


MONETARY  SYSTEMS  OF  LEADING  NATIONS      489 

for   all   taxes,   customs,    and   other   public   dues. "     ( §  16, 
Federal  Reserve  Act  of  Dec.  23,  1913.) 

The  redemption  rights  of  United  States  moneys. — The 
following  rules  governing  the  redemption  of  the  several 
forms  of  money  in  this  country  are  taken  from  "Circular 
No.  62"  issued  by  the  Treasury  Department.6 

"Gold  coins  and  standard  silver  dollars,  being  standard  coins 
of  the  United  States,  are  not  'redeemable.' 

"Subsidiary  coins  and  minor  coins  may  be  presented,  in  sums  or 
multiples  of  $20,  to  the  Treasurer  of  the  United  States  or  to  an  as- 
sistant treasurer  for  redemption  or  exchange  into  lawful  money. 

"United  States  notes  are  redeemable  in  United  States  gold  coin 
in  any  amount  by  the  Treasurer  and  all  the  assistant  treasurers 
of  the  United  States. 

"Treasury  notes  of  1890  are  redeemable  in  the  United  States 
gold  coin  in  any  amount  by  the  Treasurer  and  all  the  assistant 
treasurers  of  the  United  States. 

"National-bank  notes  are  redeemable  in  lawful  money  of  the 
United  States  by  the  Treasurer,  but  not  by  the  assistant  treas- 
urers. They  are  also  redeemable  at  the  bank  of  issue.  In  order 
to  provide  for  the  redemption  of  its  notes  when  presented,  every 
national  bank  is  required  by  law  to  keep  on  deposit  with  the 
Treasurer  a  sum  equal  to  5%  of  its  circulation. 

"Gold  certificates  being  receipts  for  gold  coin,  are  redeemable 
in  such  coin  by  the  Treasurer  and  all  assistant  treasurers  of  the 
United  States. 

"Silver  certificates  are  receipts  for  standard  silver  dollars  de- 
posited, and  are  redeemable  in  such  dollars  only. 

"  '(Join'  obligations  of  the  Government  are  redeemed  in  gold  coin 
when  gold  is  demanded  and  in  silver  when  silver  is  demanded." 

The  treasury  offices  make  a  practice,  however,  of  paying 
out  gold  on  requesl   in  redeeming  any  form  of  money. 

Tolerance. — Tolerance  is  an  allowance  made  by  law  for 
the  deviation  of  actual  coin  from  its  exact  legal  specifica- 
tions.    The  different  kinds  of  tolerance  are  here  shown. 

8  As  cited  immediately  above,  p.  488. 


190  FOWEIGN  EXCHANGE 

f  Error  in  fineness 


Tolerance 


For  error  in  minting  ,  T, 

LError  in  gross  weight 

For  abrasion  (or  loss  of  weight  in  circulation). 


*  The  tolerance  for  error  in  minting  is  also  known  as  the 
"remedy." 

The  tolerance  for  error  in  fineness  is  in  this  country  one- 
thousandth  for  gold  coin,  and  three-thousandths  for  silver.7 
That  is,  a  gold  coin  might  come  from  the  mint  either  .901 
or  .899  fine  and  be  a  good  coin  at  law.  However,  the  in- 
structions of  the  Director  of  the  Mint  state  that  in  practice 
bullion  should  not  be  coined  which  varies  outside  of  the 
limits  of  8997/io  and  .9001io.s  Thus  the  mints  are  directed 
to  take  advantage  of  not  more  than  three-tenths  of  the 
maximum  legal  tolerance  for  error  in  fineness. 

The  tolerance  for  error  in  the  gross  weight  of  newly 
minted  coin  is  defined  in  two  w'aj's.  (1)  When  a  coin  is 
weighed  by  itself:  For  the  double-eagle  and  the  eagle  the 
tolerance  is  one-half  grain,  and  for  smaller  gold  coins  one- 
quarter  grain.9  (For  all  silver  coin  it  is  one  and  one-half 
grains  for  each  coin.)  (2)  "When  a  number  of  coins  are 
weighed  together :  ' '  And  in  weighing  a  number  of  pieces 
together,  the  deviation  from  the  standard  weight  shall  not 
exceed  one-hundredth  of  an  ounce  in  five  thousand  dollars 
in  double-eagles,  eagles,  half-eagles,  or  quarter-eagles,  in 
one  thousand  three-dollar  pieces,  and  in  one  thousand  one- 
dollar  pieces. ' '  10  The  following  table  of  tolerances  is  self- 
explanatory. 

7  Revised  Statutes  of  the  U.  S.,  §  3533. 

8  "General  Instructions  and  Regulations,"  etc.  (before  cited),  Art. 
22,  §  2.  p.  25. 

o  Revised  Statutes  of  the  U.  S.,  §  3,535. 

io  R.  S.,  §  3535.  The  three-dollar  and  one-dollar  pieces  are  no 
longer  coined, 


MONETARY  SYSTEMS  OF  LEADING  NATIONS      491 
TOLERANCE  IN  GROSS  WEIGHT  OF  NEW  GOLD  COIN  " 


Tolerance 

Standard 

allowed  by 

Minimum 

Denominations 

or  legal 

law  on  in- 

legal  weight 

of  coins 

weight 

vidual  pieces 

of  new  coins 

Grains 

Grains 

Grains 

Double-eagle 

51C.0 

0.50 

515.50 

Eagle 

258.0 

.50 

257.50 

Half -eagle 

129.0 

.25 

128.75 

Quarter-eagle 

64.5 

.25 

64.25 

The  tolerance  for  abrasion  in  circulation. — The  law  pro- 
vide.? that  a  gold  coin  may  suffer  a  loss  of  weight  by  natural 
abrasion  at  the  rate  of  one-half  per  cent,  in  twenty  years, 
the  total  abrasion  not  to  exceed  one-half  per  cent.  Thus 
a  coin  one  year  old  must  not  show  an  abrasion  in  excess 
of  one-fortieth  per  cent.,  one  five  years  old  not  in  excess 
of  one-eighth  per  cent.,  and  so  on.  The  effect  of  excessive 
abrasion  is  to  make  a  coin  cease  to  be  legal  tender  at  its 
"full"  or  "nominal"  value,  although  it  retains  legal  tender 
power  in  proportion  to  its  actual  weight.12  The  "least 
current  weights"  of  our  present  gold  coins  are  indicated 
in  the  following  table. 


LEAST  CURRENT  WEIGHTS  U.  S.  GOLD  COINS  13 


One-half 

Actual 

per  cent. 

Least  cur- 

Annual 

coefficient 

Denomina- 

Standard 

abrasion 

rent  weight 

abrasion 

of  annual 

tions 

or  legal 

after  20 

after  20 

within 

abrasion  from 

of  coins 

weight 

years'  wear 

years'  wear 

legal  limit 

experiments 

Grains 

Grains 

Grains 

Grains 

Grains 

Double-eagle 

516.0 

2.58 

513.42 

0.129 

0.0860 

Eagle 

258.0 

1.29 

256.71 

.0645 

.0430 

Half-eagle 

129.0 

.643 

128.355 

.0322 

.0215 

Quarter-eagle 

64.5 

.322 

64.178 

.0161 

.0107 

ii  From  "General  Instructions  and  Regulations,"  etc.  (before 
cited),  p.  22. 

"Revised  Statutes,  8  3585. 

"From  "General  Instructions  and  Regulations,"  etc.  (before 
cited),  p.  22. 


492 


FOREKiX  EXCHANGE 


§  129.  Technical    detail.     England.— 

THE  COINS  OF  ENGLAND 
Gold 


Mint 

Gross 

Fineness 

Fine 

Fine  Gold 

Parity 

Weight 

in  thou- 

Gold 

(metric 

in  U.  S. 

Denomination 

(grains) 

sandths 

(grains) 

grams ) 

Dollars 

Five-pound 

616.37239 

.910% 

565.0079 

36. 0 110 

$24.3328 

Two-pound 

246.54895 

.916% 

220.0031 

14.0447 

9.7331 

Sovereign      (£1) 

123.27447 

.916% 

113.0015 

7.3223 

4.8665 

Half-sovereign 

(10s.)    

G1.G3723 

.916% 

50.5007 

3.GG11 

2.4332 

(There  are  virtually  no  £5  and  £2  coins  in  circulation.) 

Silver 

Fine 

Gross  weight  Contents 

Denominations                                  (grains)            Fineness  (grains) 

Crown    (5s.)     430.36                 .925  403.03 

Half-crown    (2Vjs.)     218. IS                 .925  201.81 

Florin     (2s.)     174.54                  .925  161.45 

Shilling    87.27                 .925  80.72 

Sixpence     43.03                  .925  40.36 

Threepence    21.81                 .925  20.18 

Bronze 

Gross  Weight  (grains)  Alloy 

Penny     145.83                  f  95%  copper 

Half-penny   87.50                 J  4%  tin 

Farthing     43.75  1%  zinc 


PAPER  MONEY  IN  GREAT  BRITAIN 

Bank  of  England  Notes  (in  denominations  of  £5,  10,  20,  50,  100, 
200,  500,  and  1,000)  were  prior  to  the  war  the  only  legal  tender 
paper  money  of  England.  The  Bank  of  England  is  divided 
into  two  distinct  parts  known  as  the  Banking  Department  and 
the  Issue  Department.  The  latter  has  sole  charge  of  the  issue 
and  redemption  of  Bank  of  England  notes,  and  this  is  its  only 
function.     On  March  6,  1912,  there  were  £56,092,145  of  notes 


MONETARY  SYSTEMS  OF  LEADING  NATIONS      493 

outstanding  and  the  Issue  Department  possessed  exactly 
£56,092,145  of  assets  to  cover  them.  It  is  generally  assumed 
that  these  assets  are  specially  pledged  for  the  payment  of 
notes  alone,  but  the  law  is  not  really  explicit  on  this  point, 
and  Mr.  George  Clare  states,  "good  authority"  has  held  that 
should  the  bank  fail,  the  assets  of  the  Issue  Department  would 
become  a  part  of  the  general  fund  of  resources  against  which 
depositors  and  note-holders  would  have  merely  equal  claims.11 
The  assets  held  by  the  Issue  Department  fall  into  two  parts: 
(1)  gold  coin  and  bullion  (amounting  to  £37,642,145  on 
March  6,  1912)  and  (2)  British  government  debt  and  other 
securities  (amounting  to  £18,450,000).  In  consequence  the 
entire  circulation  of  the  Bank  is  thought  of  as  divided  into  the 
two  parts  known  as  the  "covered"  and  the  "uncovered  issue." 
Thus  on  Feb.  12,  1919,  the  issue  was  constituted  as  follows: 

Covered    Issue  £80,570,795 

Uncovered  Issue  18,450,000 


Entire  circulation         £99,020,795 

The  uncovered  issue  is  not  without  backing  but  is  "uncovered" 
so  far  as  specie  is  concerned.  Under  the  law,  the  uncovered 
issue  of  the  Bank  cannot  be  increased  except  by  the  addition 
to  it  of  two-thirds  of  any  issue  rights  which  may  in  the  future 
be  surrendered  by  those  "country  banks"  which  still  possess 
a  circulation.  (See  "Notes  of  Other  Banks"  hereunder.) 
The  maximum  to  which  the  uncovered  issue  can  ever  attain 
under  this  provision  is  £19,616,000. 

Except  for  this,  the  uncovered  issue  of  the  Bank  is  an  un- 
changing quantity.  The  fluctuations  in  the  total  outstanding 
circulation  take  place  solely  in  the  shape  of  the  expansion  of 
contraction  of  the  covered  part  of  the  issue.  Notes  are  regu- 
larly paid  out  by  the  Issue  Department  only  in  exchange  for 
gold,  and  they  are  retired  only  upon  redemption  in  gold. 
Since   the   covered   notes   to-day   constitute   two-thirds   of  the 

14  "A  Money  Market  Primer,"  2d.  ed.  1903,  }>■  17.  .Mr.  (hire  Bays 
by  way  of  comfort,  "though  interesting  in  theory,  the  question  is,  of 
course,  of  no  practical   importance." 


494  FOREIGN  EXCHANGE 

whole  issue,  and  since  the  retirement  of  notes  by  the  public 
in  such  volume  as  to  reach  the  uncovered  part  is  almost  un- 
thinkable.1 r'  the  Bank  of  England  note  is  in  its  practical  aspects 
a  gold  certificate.  Suppose  the  United  States  government  had 
$800,000,000  of  gold  certificates  outstanding,  and  should  with 
the  consent  of  their  holders  remove  about  $300,000,000  of  the 
gold  carried  in  the  special  reserve,  and  substitute  an  equal 
amount  of  its  own  bonds  payable  in  gold.  This  would  make 
the  gold  certificate  very  similar  to  the  Bank  of  England  note 
as  it  is  to-day.  The  law  permits  the  Issue  Department  to 
include  in  the  specie  held  to  cover  notes,  a  one-fifth  propor- 
tion of  silver  coin,  but  the  Bank  has  long  since  ceased  to  avail 
itself  of  this  privilege.  The  Banking  Department  keeps  its 
own  separate  cash  reserve  chiefly  in  the  shape  of  the  notes  of 
the  Issue  Department.  It  has  to  give  up  gold  to  obtain  these 
notes  and  holds  them  instead  of  gold  only  as  a  matter  of  con- 
venience. On  March  6,  1912,  the  Banking  Department  held 
£27,839,000  of  notes  as  cash,  and  there  were  therefore  but 
£28,253,000  of  notes  held  by  the  outside  public.  In  many 
eases  the  figure  given  by  statisticians  as  "the  circulation"  of 
the  Bank  is  merely  the  figure  for  the  notes  held  by  the  outside 
public. 
Notes  of  Other  English  Banks. — A  number  of  banks  located  in 
England  and  Wales  have  the  right  to  issue  circulating  notes, 
but  the  total  of  their  issue  is  at  present  subject  to  an  absolute 
maximum  limit  of  £1,166,000.  These  notes  have  no  legal 
tender  power  and  have,  in  fact,  only  local  currency.  When- 
ever one  of  these  so-called  "country  banks"  goes  out  of  exist- 
ence or  otherwise  gives  up  its  issue  rights,  these  rights  disap- 
pear never  to  be  revived  as  such.  The  law  provides  that  %  of 
such  lapsed  rights  may  be  added  to  the  Bank  of  England's 
"uncovered"  issue,  that  is,  issue  to  be  covered  by  securities. 
The  present  law   (the  Peel  Act)   governing  the  circulation  of 

isAt  none  of  the  times  when  the  Bank  of  England  has  been  in 
difficulties,  since  the  separation  of  the  Issue  and  Banking  Depart- 
ments, has  there  been  the  slightest  suspicion  of  the  notes  on  the 
part  of  the  public.  There  has  never  been  such  a  thing  as  a  run  on 
the  Issue  Department. 


MONETARY  SYSTEMS  OF  LEADING  NATIONS      495 

notes  in  England  and  Wales  was  passed  in  1844.  Since  1844 
the  uncovered  issue  of  the  Bank  of  England  has  grown  from 
£14,000,000  to  £18,450,000.  The  law  was  designed  with  a 
view  to  the  ultimate  extinguishment  of  the  country  bank 
issues. 

Scotch  and  Irish  Baoik  Notes. — Several  banks  in  Scotland  and 
several  in  Ireland  issue  notes  which  circulate  freely  in  their 
respective  countries,  but  which  are  at  a  discount  of  Id.  per 
pound  in  dealings  between  banks  in  London.  These  notes 
have  no  legal  tender  power. 

English  Government  Currency  Notes. — The  act  of  the  6th  of 
August,  1914,  authorized  the  English  Treasury  to  issue  circu- 
lating notes  (in  denominations  of  £1  and  of  10s.)  known  as 
Currency  Notes,  which  have  unlimited  legal  tender  power  and 
are  redeemable  in  gold  coin  on  demand  at  the  Bank  of  Eng- 
land, where  the  Treasury  is  to  keep  funds  for  the  purpose. 
This  new  element  of  English  paper  money  was  created  just 
after  the  country  entered  the  great  war,  obviously  under  the 
stress  of  that  event.  Probably  it  will  be  done  away  with  in 
time,  but  in  February,  1919,  there  were  outstanding  over 
£300,000,000  of  these  notes  (and  certificates  representing 
them).  The  purpose  of  the  issue  was  to  enable  the  govern- 
ment to  make  advances  to  the  banks.  The  government  was 
secured  by  taking  a  floating  prior  lien  on  all  the  assets  of  the 
banks  receiving  the  advances.  It  charged  for  the  accommoda- 
tion at  the  Bank  of  England  rate.  The  conferring  of  the 
full  legal  tender  power  upon  the  notes  made  them  so  much 
the  more  appropriate  as  an  emergency  currency  for  the  dis- 
charge of  debts  throughout  the  frightened  business  community. 

LEGAL  TENDER  IN  ENGLAND  ia 

Standard  gold  coin  has  unlimited  legal  tender  power  in  the  entire 
United  Kingdom. 

i6  "For  the  purpose  of  meeting  immediate  exigencies"  postal  orders 
were  made  legal  tender  in  the  United  Kingdom  by  the  acl  of  August 
6th,  1914,  until  the  removal  of  this  power  by  proclamation.  In  a 
similar  manner  the  acl    made  bank   notes  issued   in   Scut  land  and  Ire- 


496  FOREIGN  EXCHANGE 

Silver  coin  is  lopral  tender  in  the  United  Kingdom  up  to  the 
amount  of  40  shillings  in  a  single  payment. 

Bronze  coin.  Pence  and  half-pence  are  legal  tender  in  single 
payments  not  to  exceed  1  shilling,  and  farthings  in  payments 
not  to  exceed  6d. 

Ba>ik  of  England  Notes  are  legal  tender  in  unlimited  amounts  in 
England  and  Wales  but  not  legal  tender  in  Scotland  or  Ireland. 
These  notes  are  not  legal  tender  "at  the  Bank  of  England  it- 
self," which  means  practically,  not  legal  tender  when  offered 
by  this  institution  to  its  creditors. 

Currency  Notes  have  unlimited  legal  tender  power  throughout 
the  United  Kingdom. 

TOLERANCE 

The  tolerance  for  error  in  fineness,  allowed  the  mint 
for  gold  coin,  is  %ooo-  That  is,  gold  coin  may  vary 
from  .914%  to  .918%.  For  error  in  gross  weight  it 
is  1(Koo  of  1%-  For  loss  of  weight  in  circulation,  the 
sovereign,  having  a  legal  weight  of  123.27447  grains,  may 
in  consequence  of  abrasion  fall  to  122.5  grains  without 
losing  its  legal  tender  power.  Sovereigns  below  this  weight 
are  not  legal  currency,  but  light  gold  coins  are  now  re- 
ceivable by  the  Bank  of  England  for  the  account  of  the 
Mint,  at  their  full  nominal  value,17  the  cost  of  supplying 
the  losses  due  to  abrasion  being  shifted  to  the  government, 
with  whom  it  belongs.  (The  half-sovereign  with  a  legal 
weight  of  61.63723  grains  has  a  least  current  weight  of 
61.5  grains.)  The  permissible  abrasion  in  the  sovereign  is 
then  about  %  of  a  grain  (a  loss  of  6%  parts  in  1,000). 
The  Bank  of  England  rarely  delivers  sovereigns  which  have 
a  deficiency  of  more  than  2%  parts  in  1,000,  weighed  in 
bulk.18 

land  legal  tender  in  Scotland  and  Ireland  respectively  until  revoca- 
tion by  proclamation.  The  text  of  this  act  may  be  found  in  one  of 
the  appendices  to  Hartley  Withers'  "War  and  Lombard  Street." 

i^Deutsch,  "Arbitrage,"  London   (1904),  p.  18. 

is  Tates,,  "Modern  Cambist"   (as  already  cited),  p.  14. 


MONETARY  SYSTEMS  OF  LEADING  NATIONS      497 
§  130.  The  Mint  price  of  gold  in  the  United  States. — 

Standard  Bullion 

The  standard  bullion  of  the  United  States  is  900  parts 
of  fine  gold  to  the  1,000.  The  100  parts  not  gold,  called 
in  this  connection  the  alloy,  may  consist  wholly  of  copper, 
but  a  proportion  of  silver  equal  to  Vio  of  the  alloy  is  per- 
mitted by  law.  Silver  will  be  left  in  only  in  cases  where  it 
is  present  in  such  small  quantities  that  it  does  not  pay  to 
refine  it  out.  Such  silver  as  remains  in  the  bullion,  though 
by  nature  a  valuable  metal,  has  no  effect  upon  the  value 
of  the  bullion,  except  that  its  presence  saves  the  use  of 
an  equal  weight  of  copper  which  is  a  negligible  matter. 
This  silver  is  like  silver  in  the  moon,  or  too  far  under 
ground  to  be  worth  anything.19 

The  price  of  standard  gold  bullion  in  the  United  States  is 

$18.60465  per  ounce  troy,  without  deduction  or  charge. 
This  is  computed  in  the  following  manner: 

Data.     The   statutes   provide 

1.  That  25.8  grains  of  standard  gold  shall  constitute  a 

dollar,  and 

2.  That  the  depositor  of  such  metal  at  the  mint  shall 

be  entitled  to  receive  back  all  the  coin  it  will  make, 
without  charge. 

An  ounce,  or  480  grains,  of  standard  gold  will  make 
18.60465  dollars. 

480  -h  25.8  =  18.60465 

ifJ  In  practice  the  presence  of  very  small  quantities  of  impurities 
in  standard  bullion  lias  i<>  lie  tolerated  by  (lie  mint,  if  they  arc  nol 
injurious  to  the  coining  machinery,  Imt  the  line  "old,  to  which  copper 
is  added  to  produce  standard  bullion,  is  usually  run  up  above  ,999 
in  fineness. 


498  FOREIGN  EXCHANGE 

Iho  mint  price  for  standard  gold  bullion  is  also  some- 
times expressed  as 

$800  for  43  ounces. 

If  the  mint  gives  $1  for  25.8  grains,  it  will  give  $800  for 
800  X  25.8,  or  20,640  grains,  and  this  happens  to  be  exactly 
43  ounces  troy. 

Non-Standard  Bullion 

The  mint  price  for  non-standard  gold  bullion  is  in  the 
United  States 

$20.67183  per  ounce  of  fine  contents,  less  charges. 

This  is  best  expressed  by  saying  that  the  basic  price  for 
non-standard  gold  bullion  is  $20.67183  per  ounce  of  pure 
gold  contents.  The  computation  of  this  price  was  explained 
in  §  109.  In  no  case  does  the  depositor  of  non-standard 
bullion  receive  payment  for  its  fine  contents  at  the  full 
rate  of  $20.67183  per  ounce,  because  there  is  always  some 
charge  to  cover  the  cost  of  standardizing.  This  statement 
applies  even  to  bars  of  fine  gold,  or  of  "mint  fine"  gold, 
the  latter  signifying  gold  containing  such  trifling  impuri- 
ties that  the  mint  does  not  demand  their  elimination. 
These  impurities  count  of  course  only  as  an  unavoidable 
evil.  They  go  along  with  the  gold  but  do  not  count  as 
gold  in  the  weighing. 

The  charges  to  which  non-standard  bullion  may  be  sub- 
ject are  four  in  number,  as  follows. 

(1)  A  melting  charge  of  the  exceedingly  small  amount  of  $1 
per  1,000  ounces  of  bullion.  Deposits  of  uncurrent  U.  S.  gold 
coin  and  of  "mint-fine"  bars  are  exempt  from  this  charge. 

(2)  A  parting  and  refining  charge  varying  from  *£  cent  to 
4  cents  per  ounce  gross  weight  of  the  deposited  bullion.  The 
mints   accept   bullion   not   below   .200   fineness   in   gold,  if  suf- 


MONETARY  SYSTEMS  OF  LEADING  NATIONS      499 

ficiently  homogeneous  for  assay,  except  that  bullion  containing 
arsenic  or  other  elements  objectionable  in  treatment  may  be  re- 
jected. The  parting  and  refining  charges  vary  according  to  the 
percentage  of  gold  in  the  bullion  and  according  to  the  character 
of  its  other  constituents.  These  charges  are  fixed  by  the  Director 
of  the  Mint.20  Exempt  from  the  parting  and  refining  charges 
are  (1)  foreign  coin  of  our  standard  of  fineness  or  above,  and 
(2)  bullion  containing  .992  thousandths  of  gold  and  upwards, 
which  does  not  contain  substances  (such  as  iron,  lead,  tin,  etc.) 
which  must  be  refined  out  before  coining.  The  latter  bullion 
may  contain  silver  or  copper.  Silver  contained  in  gold  deposits 
is  paid  for  by  the  government  at  a  rate  fixed  from  time  to  time 
by  the  Director  of  the  Mint,  with  the  approval  of  the  Secretary 
of  the  Treasury.  This  rate  follows  the  current  market  quota- 
tions. But  where  the  silver  constitutes  no  more  than  .008  of 
the  bullion  no  accounting  is  made  for  it,  since  it  is  in  practice 
utilized  simply  as  a  part  of  the  alloy.21 

(3)  A  toughening  charge  equal  to  the  cost  to  the  government 
of  the  necessary  treatment  of  the  bullion,  is  exacted  whenever 
the  deposited  bullion  contains  certain  elements  which  must  come 
out  in  order  to  make  assay  and  coining  feasible. 

(4)  A  charge  for  copper  alloy  is  levied  upon  all  bullion  to 
which  copper  must  be  added  to  bring  it  to  the  standard.  This 
charge  of  2£  per  ounce  of  copper  actually  required. 

The  mints  of  the  United  States  receive  for  coinage  bul- 
lion of  a  great  variety  of  degrees  of  fineness.     It  is  not 

20  At  present  writing  the  latest  schedule  of  the  mint's  charges  was 
the  one  published  March  27,  1911,  to  take  effect  May  1,  1911. 
(Leaflet,  U.   S.  Mint  Service,  Form  92.) 

2i  If  it  paid  to  refine  out  (or  make  a  "parting"  of)  so  small  a 
proportion  of  silver,  this  would  of  course  be  done.  The  silver  could 
be  replaced  by  copper.  But  silver  appearing  in  quantities  too  small 
for  profitable  extraction  is  commercially  unavailable.  It  has  no 
value  and  does  not  affect  the  value  of  the  bullion  otherwise  than  by 
saving  a  little  of  the  charge  for  copper.  It  is  like  good  silver,  say, 
so  deep  under  the  ground  as  to  be  worthless. 


500  FOREIGN  EXCHANGE 

our  endeavor  to  go  exhaustively  into  the  technical  subject 
of  the  appraisal  of  the  coining  value  and  purchase  price 
of  such  metal,  but  it  will  be  well  to  consider  an  example 
or  two.  Suppose  that  10,000  ounces  of  British  sovereigns 
(coins  of  £1  each)  are  offered  an  American  mint.  How 
will  the  amount  payable  to  the  depositor  of  this  gold  be 
computed  ? 

SALE  OF  10,000  OUNCES  OF  BRITISH  SOVEREIGNS  TO 
THE  UNITED  STATES  MINT  22 

When  melted  and  assayed  this  gold  shows,  say,  a  fineness  of  .9165 
(which  is  just  a  shade  under  the  legal  fineness  and  well  within 
the  limit  of  tolerance  allowed  the  English  mint). 

10,000  ounces  contain  therefore  9,165  oz.  fine  gold. 

9,165  ounces   at   the    basic   price   of   $20.67183    are 

valued  at   $189,457.32 

(i.e.,  9,165  X  20.67183) 

The  following  charges  are  levied: 

Melting  charge.     (1  per  1,000  oz.) $10.00 

Parting  and  refining 

(none  for  this  kind  of  deposit) 
Toughening  (none) 
Charge  for  extra  copper  at  2c  an  ounce. . .     3.67 

Total   charge    $13.67 

Mint's  net  price  for  the  10,000  oz $189,443.65 

CALCULATION'    OP   THE   CHARGE   FOR   COPPER 

British  coin  has  M2th  alloy  as  against  ^oth  alloy  in  the  United 
States  standard  gold,  therefore  copper  must  be  added  to  Brit- 
ish standard  gold  to  bring  it  to  the  U.  S.  standard. 

The  copper  in  U.  S.  standard  gold  weighs  10%ooths  or  %th  as 
much  as  fine  gold. 

22  10,000  ounces  would  be  £38,038  of  coin  extremely  close  to  full 
weight. 


MONETARY  SYSTEMS  OF  LEADING  NATIONS      501 

Therefore  9,165  oz.  of  fine  gold 
will     make     9,165  +  %th     of 

9,165  or  10,lS3]-6  ounces  of  standard  gold. 
The  British  gold  weighs     10,000      ounces 
It  lacks  of  copper  18316  ounces  to  make  it  9iotks  fine. 
lSS1/^  ounces  @  2ti  =  $3.67  the  charge  for  additional  alloy. 

Consider  for  a  second  example  a 

SALE  OF  10,000  OUNCES  OF  MINT  FINE  BARS 
ASSAYING  AT  .9995 

Fine  contents    9,995  oz. 

Basic  price,  9,995  X  20.67183  $206,614.94 

Charge  for  copper 22.1 0 

Paid  by  mint   $206,592.84 

THE   CHARGE   FOR   COPPER 

Standard  gold  being  9  parts  gold  and  1  part  alloy, 

the  alloy  equals  M>th  in  weight  of  the  fine  gold. 

The  alloy  must  be  %th  of  9,995  ounces  or 1,110.55  oz. 

Of  this  the  5  ounces  of  impurity  form  a  part,  leaving 

copper  to  be  added 1,105.55  oz. 

This  will  cost,  at  2?  an  ounce $22.10 

The  law  does  not  require  the  mints  to  accept  deposits 
of  gold  bullion  of  less  than  $100  in  value,  but  in  actual 
practice  they  buy  all  offered  that  is  sufficiently  homogene- 
ous to  allow  the  value  to  be  readily  ascertained.  Bullion 
is  sometimes  rejected  for  containing  arsenic  and  other 
objectionable  elements,  but  the  American  mints  will  receive 
bullion  containing  iridium.  The  mint  must  take  this  metal 
out  to  avoid  damage  to  dies.  It  does  so  but  makes  no 
allowance  to  the  depositor  for  the  value  of  the  iridium 
itself. 

Bullion  is  paid  for  in  full  as  soon  as  its  value  is  deter- 
mined. The  Superintendent  of  the  Mini  may,  in  bis  dis- 
cretion, make  immediate  advances  on  deposits  by  well  known 


502  FOREIGN  EXCHANGE 

firms  before  the  determination  of  the  precise  value,  such 
advances  not  to  exceed  90%  of  the  estimated  value.  Pay- 
ments to  depositors  are  made  in  various  ways.  The  New 
York  Assay  Office  always  pays  by  draft  on  the  Assistant 
Treasurer  in  New  York,  whose  office  is  next  door.  The 
Philadelphia  mint  pays  in  gold  coin  over  the  counter.  The 
San  Francisco  mint  pays  in  coin  over  the  counter,  or  by 
draft  on  the  San  Francisco  Assistant  Treasurer,  or  by 
draft  on  the  New  York  Assistant  Treasurer.23 

The  sale  and,  exchange  of  gold  bars  by  the  mints. — 
Under  the  authority  of  the  Act  of  March  3,  1891,  the  Phila- 
delphia and  San  Francisco  mints  and  the  New  York  Assay 
Office  sell  mint  fine  bars  to  the  public  for  gold  coin  at  the 
price  of  $20.67183  per  ounce  of  fine  contents,  plus  a  charge 
of  40^  to  the  $1,000  worth,  to  cover  the  immediate  cost 
of  manufacture.  These  bars  are  a  favorite  form  of  gold 
for  export,  but  large  quantities  are  also  bought  for  use  in 
the  industrial  arts  within  the  country.  Under  the  statute 
the  mints  are  not  bound  to  make  these  sales,  but  are  per- 
mitted to  do  so  with  the  approval  of  the  Secretary  of  the 
Treasury.     The  smallest  sale  permitted  is  one  for  $5,000. 

§  131.  The  mint  and  bank  price  of  gold  in  England. — 
The  mint  price  of  gold  in  England  is 

£3  17s.  lOHd.  per  ounce  .916%  fine. 

The  English  law  provides  for  gratuitous  coinage  of  stand- 
ard bullion.  According  to  the  legal  weight  of  the  sovereign, 
934/£  of  these  coins  can  be  made  from  20  pounds  troy  of 
standard  bullion,24  or  1,869  can  be  made  from  40  pounds. 
The  consequence  is  that  the  mint  price  for  standard  gold 


23  For  many  points  in  thk  section  the  writer  is  indebted  to  the 
kindness  of  Mr.  George  E.  Roberts,  former  Pirector  of  the  Mint  of 
the  United  States. 

24  The  earlier  English  monetary  statutes  defined  the  sovereign 
merely  by  providing  that  934V2  should  be  coined  from  20  Jbs.  Trov  of 
standard  gold. 


MONETARY  SYSTEMS  OF  LEADING  NATIONS        503 

is  £3  17s.  103-^d.  per  ounce.  This  figure  results  from  the 
calculation  given  below. 

40  pounds  troy    =480  ounces 
480  ounces  =£1,869  (i.e. — makes  1,869  sovereigns). 

1  ounce  =*sff  of  £1,869. 

Divide  480  into  £1,869 

This  may  be  done  so  as  to  yield  pounds  and  a  decimal 
fraction  of  a  pound,  and  the  latter  converted  into  s.  and  d.; 
or  the  following  method  may  be  pursued. 

480  )  1,869  pounds  (  3  pounds 
1,440 


429  pounds  left  over 

20  (number  of  shillings  to  a  pound) 


480  )  8,580  shillings  left  over  ( 17  shillings 
480 


3,780 
3,360 


420  shillings  left  over 
12  (pence  to  a  shilling) 


840 
420 


480  )  5,040  pence  left  over  ( 10.5  pence 
480 


2,400 
2,400 


Answer    £3  17s.  lO^d. 

The  terms  on  which  the  mint  will  pay  this  price  to  the  de- 
positors of  gold  bullion,  are  (1)  the  coin  is  returnable  to  the 
depositor  only  after  the  period  required  for  actual  coinage, 
two  to  three  weeks,  and  (2)  no  deposit  is  received  of  a  value 
of  less  than  £10,000. 


504  FOREIGN   K.M'll AXtiK 

The  Bank  of  England's  Buying  Price  for  (lold. — In 
practice  all  gold  bullion  which  the  owners  desire  to  convert 
into  British  legal  tender  is  sold  to  the  Bank  of  England 
instead  of  the  mint.  The  Bank  then  has  coin  struck  from 
time  to  time  according  to  its  needs.  In  practice  the  Bank 
of  England  has  become  the  sole  depositor  at  the  mint  proper. 

The  minimum  buying  price  of  the  Bank  of  England 
for  an  ounce  of  gold  n  btha  fine  is £3  17s.  9d. 

The  Act  of  1844  compels  the  Bank  to  exchange  its  notes 
for  standard  gold  bullion  at  the  rate  of  £3-17-9  per  stand- 
ard ounce.  Since  notes  are  redeemable  in  gold  coin  on 
demand  at  the  Bank  itself,  any  one  can  procure  coin  for 
bullion  at  the  Batik  without  resort  to  the  mint.  Uncoined 
bars  in  the  possession  of  the  Bank  count  as  legal  reserve 
against  its  outstanding  notes,  and  it  is  for  this  reason  that 
the  institution  does  not  need  to  have  all  the  bars  which 
it  buys  converted  into  actual  coin. 

AVhile  the  Bank  may  raise  its  buying  price  for  gold  as 
far  above  £3  17s.  9d.  as  it  sees  fit,  in  point  of  fact  for 
reasons  to  be  explained  presently,  it  could  never  while 
itself  maintaining  specie  payments  have  a  motive  for  of- 
fering at  the  utmost  more  than  £3  18s.  OMid.  According 
to  information  kindly  furnished  the  writer  by  Mr.  J.  E. 
Nairne,  Chief  Cashier  of  the  Bank,  the  highest  recorded 
price  paid  by  this  institution  for  bars  is  £3  17s.  lO^d. 
The  letter  containing  this  information  was  written  before 
the  war,  but  so  far  as  the  writer  knowrs  the  Bank  has  not 
in  later  times  made  offers  above  this  figure. 

Terms  upon  which  the  Bank  buys  gold  bullion.25 — (1) 
The  metal  must  be  melted  into  bars  of  approximately  400 
ounces  in  weight  and  of  a  designated  shape.  A  charge  at 
the  rate  of  /4d.  per  ounce  is  made  for  the  services  of  the 

25  According  to  Tate's  "Modern  Cambist,"  24th  edition,  1908,  pp. 
15  and  16. 


MONETARY  SYSTEMS  OF  LEADING  NATIONS      505 

melters  officially  recognized  by  the  Bank.  The  Bank  does 
not  buy  a  smaller  quantity  than  400  ounces.  (2)  The 
Bank  makes  no  stipulation  as  to  the  fineness  of  the  bars 
but  it  is  rare  for  gold  under  the  British  standard  of  .916% 
to  be  offered.  The  detection  in  a  bar  of  iridium  or  any 
other  substance  making  it  unsuitable  for  coinage,  would 
lead  to  its  rejection.  The  private  refineries  charge  Md. 
per  ounce  for  taking  iridium  out,  and  its  presence  in  gold 
usually  leads  to  the  sale  of  the  latter  to  some  refiner  at  a 
price  reduced  by  *4d.  per  ounce.  (3)  The  gold  must  be 
subjected  to  a  triple  test  by  the  Bank's  official  assayers, 
at  an  expense  to  the  seller  of  about  4s.  6d.  per  bar.  The 
amount  of  standard  gold  contained  in  a  bar,  and  hence  its 
price,  is  determined  on  the  basis  of  these  assays.  American 
and  other  foreign  bars,  the  fineness  of  which  has  already 
been  determined  abroad,  may  be  taken  by  the  Bank  without 
further  assay  from  sellers  of  recognized  standing.  The 
seller  is  in  such  cases,  however,  required  to  give  a  kind  of 
bond  of  indemnity  against  the  possible  discovery  of  error 
in  the  indicated  fineness.  (4)  The  Bank  weighs  gold  in 
ounces  and  decimal  fractions  of  ounces  (instead  of  in 
grains)  and  does  not  take  into  account  smaller  fractions 
than  .025  (or  }4o  of  an  ounce).  (5)  The  Bank  price  is 
(unlike  the  mint  price)  payable  cash  down,  as  soon  as  the 
value  of  the  deposited  gold  is  established.  A  comparison 
shows  that 

the  Mint  price  is  £3  17s.  10y2d.,  and 

the  Bank  minimum  price  is     £3  17s.     9 


the  difference  is  1 '  -<1.    per  oz. 

When  going  to  the  mint,  the  Bank  will,  as  already  ex- 
plained, have  to  wail  for  the  coining  to  l>e  finished  before 
receiving  back  sovereigns.  The  difference  between  its  legal 
minimum  price  and  the  mini  price  is  usually  accounted  for 


506  FOREIGN  EXCHANGE 

as  being  an  allowance  of  interest  to  the  Bank  as  com- 
pensation for  tlic  average  period  of  this  delay.  l%d.  is 
almost  exactly  3%  interest  on  £3  17s.  9d.  for  20  days. 

In  contrast  with  the  American  mints,  the  British  mint 
bears  the  cost  of  any  copper  alloy  which  may  need  to  be 
added  to  a  bar  to  bring  it  to  standard  fineness  for  coinage. 
Therefore  when  bullion  with  a  fineness  above  the  stand- 
ard contains  no  impurities  that  must  be  removed  and  dif- 
fers from  the  standard  only  by  the  lack  of  a  certain  amount 
of  copper,  it  is  evaluated  by  the  Bank  as  being  worth  the 
same  as  the  amount  of  standard  bullion  which  can  be  made 
from  it.  Thus  a  bar  weighing  399.5  ounces  .998  fine,  would 
be  worth  £1,690  17s.  0.6s.  computed  as  follows: 

399.5  ounces  .998  fine   (contain  399.5  X  -998  ounces  of 

pure  gold)  =398.701  ounces  pure. 
The  alloy  in  standard  bullion,  being  Y12  of  the  whole, 

is  Ml  of  the  pure  gold  contents  (i.e.,  Vx2  is  Mi  of  xV\3l). 

Therefore  1  ounce  of  fine  gold  will  make  lMi  ounces 

of  standard  gold. 
398.701  X  1%1  =  434.946  standard  ounces. 
434.946  ounces  @  £3  17s.  9d.  per  ounce  =  £1,690  17s  6/iod. 

The  Bank's  price  for  foreign  gold  coin. — Without  legal 
compulsion,  the  Bank  both  buys  and  sells  foreign  gold 
coin.  A  price  quoted  for  coin  is  one  payable  for  the  ounce 
of  gross  weight  without  melting  and  assay.  The  Bank 
alters  its  prices  for  this  form  of  gold  as  it  sees  fit,  but 
there  are  certain  fairly  obvious  limits  beyond  which  neither 
its  buying  nor  selling  prices  may  go.  Those  who  sell  gold 
coin  to  the  Bank  always  possess  the  option  of  melting  it, 
refining  it  if  under  .916%,  paying  certain  minor  expenses, 
and  selling  it  at  least  at  the  minimum  rate  of  £3  17s.  9d. 
per  ounce  of  standard  contents.  Consequently  no  one 
would  be  likely  to  take  much  less  than  £3  16s.  3Md.  per 
ounce  for  American,  German,  French  or  other  gold  coin 


MONETARY  SYSTEMS  OF  LEADING  NATIONS      507 

which  is  supposed  to  be  .900  fine.  For,  disregarding  minor 
expenses,  when  bullion  .916%  fine  is  worth  £3  17s.  9d.,  that 
which  is  exactly  .900  fine  is  worth  just  £3  16s.  -iT^d.  Coin 
of  the  United  States,  Germany,  or  France,  will  show  an 
average  actual  fineness  very  little  under  .900,  and  the 
Bank's  lowest  buying  price  for  such  gold  is  in  fact  £3  16s. 
3a/4d.  The  Bank  no  longer  publishes  a  fixed  buying  or 
selling  price  for  foreign  coin  but  it  is  open  to  offers  the 
acceptance  of  which  depends  upon  the  circumstances  of 
the  moment.  Unofficial  information  indicates  that  the 
bm'ing  price  ranges  between  the  lower  limit  just  stated 
and  an  upper  limit  of  about  £3  16s.  7d.,  the  latter  figure 
corresponding  closely  to  a  price  for  standard  bars  of 
£3  18s. 

In  selling  foreign  coin  .900  fine  (generally  of  course 
for  export),  it  is  supposed  the  Bank  usually  asks  about 
£3  16s.  7d.  per  ounce.  It  is  also  prepared  to  sell  bars, 
but  in  ordinary  times  the  amount  sold  is  small.  The  price 
is  a  matter  of  adjustment,  but  the  Bank  has  sold  bars 
as  high  as  £3  18s.  Id.  per  standard  ounce.  The  last  occa- 
sion on  which  bars  were  sold  in  any  considerable  quantity 
was  during  the  American  crisis  of  1907. 

132.  The  London  market  price  for  bar  gold  and  its  limits. — 

Lower  limit   £3  17s.  9d. 

Upper  limit,  about £3  18s.  Id. 

Much  of  the  newly  mined  gold  of  the  world  finds  its  way 
directly  or  almost  directly  to  London,  which  lias  had  for 
many  years  past  the  greatest  of  all  markets  for  the  yellow 
metal.  Often  the  fresh  supply  goes  to  the  Bank  of  Eng- 
land at  the  latter 's  Legal  iiiininmm  buying  price.  In  these 
eases  there  has  been  nothing  better  to  do  with  it  than  to 
convert  it  into  English  sovereigns.  But  in  many  instances' 
buyers  in  the  open  market,  as  the  savin-  goes,  bid  higher 
for  it  and  carry  it  off.     These  are  mainly  foreign  buyers, 


508  FOREIGN  EXCHANGE 

many  of  them  acting  for  continental  European  banks.26 
There  is  then  an  open  market  for  gold  metal,  and  in  this 
market  demand  is  sometimes  brisk,  sometimes  dull,  and  the 
price  is  a  variable.  But  it  varies  only  to  a  trifling  extent, 
ami  we  have  already  learned  enough  to  realize  that  gold 
is  no  ordinary  market  commodity.  The  lower  limit  of 
the  price  in  London  is  £3  17s.  9d.  per  standard  ounce 
(niii  fine),  this  being  the  Bank's  minimum  buying  price, 
and  the  very  topmost  limit  appears  to  be  about  £3  18s.  Id. 
Meanwhile  the  mint  price  proper  is  £3  17s.  1014d. 

"We  must  keep  clearly  in  mind  that  an  offer  to  buy  gold 
bullion  at  a  price  is  an  offer  of  money  for  the  metal,  and 
that  so  long  as  England  is  on  the  gold  standard  it  is  an 
offer  of  gold  money  for  gold  metal.  Doubtless  payments 
for  gold  metal  are  made  by  check  quite  as  payments  for 
tin  or  zinc,  but  a  check  on  a  London  bank  is  convertible 
into  British  legal  tender  on  demand  and  under  the  assump- 
tion stated  this  will  be  either  gold  coin  itself  or  paper 
moneys  convertible  into  gold  coin. 

Now  if  the  British  mint  paid  the  full  coining  value  for 
gold  on  the  moment  of  its  deposit,  or  at  least  on  the  moment 
when  this  value  is  determined,  and  if  all  gold  coin  procur- 
able for  bank  credit  and  paper  money  were  of  absolutely 
full  legal  weight,  there  could  be  no  variation  in  the  mar- 
ket price  for  gold  metal.  An  ounce  of  metal,  standard 
metal,  of  course,  and  £3  17s.  lO^d.  would  be  interchange- 
able things.  No  seller  would  take  less  than  this,  the  mint 
price,  and  no  buyer  would  give  better  than  a  shade  more, 
because  the  very  £3  17s.  l(B£d.  of  coin  that  he  offers  con- 
tains an  ounce  of  standard  gold.  It  is  understood  we  are 
speaking  of  wholesale  dealings. 

The  lower  limit  of  the  market  price  is  underneath  the 
mint  price  for  the  primary  reason  that  the  price  at  the 

26  It  goes  without  saying  these  observations  do  not  apply  to  the 
period  of  the  war. 


MONETARY  SYSTEMS  OF  LEADING  NATIONS      509 

mint  cannot  be  obtained  without  waiting  about  three  weeks 
after  making  the  deposit  of  the  metal.  The  Bank's  legal 
minimum  spot-cash  price  is  therefore  attractive  as  com- 
pared with  the  mint  price  and  thus  comes  to  set  the  prac- 
tical minimum  for  the  market. 

The  upper  limit  exceeds  the  mint  price  for  the  reason 
that  the  average  weight  of  actual  sovereigns  which  still 
have  the  legal  tender  power  at  their  full  nominal  rating  is 
something  under  the  full  legal  weight.  At  this  point  we 
see  the  relation  of  "tolerance"27  to  the  open  market  price 
for  gold  bars.  So  far  as  the  tolerance  laws  are  effective 
in  setting  the  limits  below  which  the  pure  contents  of 
the  gold  coin  of  actual  circulation  will  not  fall,  they  serve 
to  set  a  limit  beyond  which  the  price  of  bullion  cannot 
rise.  It  is  however  the  average  actual  deficiency  in  the 
weight  of  coin  which  in  fact  establishes  the  upper  limit 
for  the  price  of  bullion.  If,  for  instance,  the  sovereigns 
delivered  by  the  Bank  of  England  in  the  redemption  of 
notes  should  never  show  a  deficiency  in  pure  contents 
greater  than  21/6  parts  in  1,000,  or  V±  of  1%,  the  market 
price  for  bullion  could  not  ascend  to  an  appreciable  extent 
above  £3  18s.  O^d.  If  sovereigns  are  of  full  weight,  they 
weigh  1  ounce  to  each  £3  17s.  10%d.  of  nominal  value.  If 
they  are  short  in  weight  by  Vi  of  1%,  it  will  take  (a  little 
more  than)  M  of  1%  more  nominal  value  of  sovereigns 
to  weigh  an  ounce.  Vi  of  1%  of  £3  17s.  lOM.  is  a  little 
over  2d.,  and  £3  17s.  lOVid.  plus  2d.  makes  £3  18s. 
Olfcd.  This  is,  in  fact,  within  ]/kl.  of  the  highest  price  for 
bar  gold  ever  experienced  in  the  London  market. 

133.  The  mint  and  bank  price  of  gold  in  France. — The 
weight  of  the  franc  has  already  been  given  as  0.32258  grams 
of  gold  .900  fine.  This,  however,  is  not  the  precise  legal 
definition  of  the  franc,  but  is  a  consequence  of  it.  The  law 
of  March   28,    1803,   laid    down    the   specifications   of   the 

27  Compare  §  129,  p.  406. 


510  FOREIGN  EXCHANGE 

gold  franc  by  providing  that  3,100  francs  should  be  coined 
from  1  kilogram  of  gold  .900  fine.28  Therefore  the  mint 
price  of  1  kilogram  of  standard  gold  would  be  3,100  francs 
were  it  not  for  the  fact  that  the  mint  makes  a  seigniorage 
or  brassage  charge  of  G.70  francs  per  kilogram.  (This  is  a 
charge  of  a  little  more  than  ^  of  1%.) 

1  kilogram  of  gold  .900  fine  will  make,  or  has  a  coining 

value  of 3,100.      francs. 

The  mint's  charge  for  coining  1  kilogram  is 6.79  francs. 

The  mint  price  (per  kg.  standard  gold)  is     3,093.30  francs. 

"When  fine  gold  is  sold  the  mint,  the  latter  makes  no  charge 
for  the  copper  which  must  be  added  to  bring  the  gold  to 
the  legal  standard,  or  rather,  +he  charge  of  6.70  francs 
per  kilogram  for  coining  also  includes  the  charge  for 
standardizing  refined  gold.  Sin<?e  ^  °f  a  kilogram  of  fine 
gold  makes  (with  copper)  1  kilogram  of  standard  gold,  the 
coining  value  and  mint  price  for  1  standard  kilogram,  as 
given  above,  are  the  coining  value  and  mint  price  of  ■£■$ 
of  a  kilogram  of  fine  gold.  Thus  the  following  figures 
result: 

1  kilogram  of  fine  gold  has 

'   a  coining  value  of  3,444.44  francs  (VX3.100) 

a  mint  price  of  3,437.      francs  (tf  X3,093.30) 

The  price  of  gold  at,  the  Bank  of  France.— The  Bank 
of  France  buys  gold  bullion  through  its  main  office  in 
Paris,  at  the  mint  price.  The  following  conditions  gov- 
ern  its  purchases.29    First  with  respect  to  gold  bars:  These 

»  This  law  also  provided  that  200  francs  of  silver  coin  should  be 
struck  from  1  kilogram  of  silver  .900  fine.  The  ratio  of  3100:200  or 
15^:1,  thus  established  between  gold  and  silver,  became  known  as 
the  "French  bimetallic  ratio,"  since  from  1801  to  1873  both  gold  and 
silver  possessed  the  right  of  free  coinage. 

*>As  given  in  Swoboda's  "Die  Arbitrage,"  13th  ed.,  1909,  edited 
by  Max  Ftirst,  pp.  418-21. 


MONETARY  SYSTEMS  OF  LEADING  NATIONS      511 

must  be  at  least  .996  fine  (unless  they  are  legal  standard 
bullion  30)  and  must  contain  no  iridium,  platinum,  arsenic, 
or  other  impurity  which  renders  the  bullion  unsuitable 
for  coinage.31  Each  bar  must  weigh  at  least  6  kilograms 
(but  must  not  exceed  13  kilograms32),  and  must  be  ac- 
companied by  certificates  of  weight  and  fineness,  one  from 
one  of  the  two  official  assayers  of  the  Bank  and  one  from 
some  outside  assayer.  The  former  certificate  costs  1EKiooo 
of  1%  of  the  value  of  the  bar,  the  latter  1  franc  per  bar. 
With  respect  to  foreign  gold  coin:  The  Bank  buys  gold  in 
this  form  without  requiring  it  to  be  cast  into  bars  and 
assayed.  The  gross  weight  of  the  deposit  of  coin  is  first 
ascertained,  and  then  the  fine  contents  are  calculated  ac- 
cording to  a  tariff  of  fineness  which  the  Bank  publishes 
and  alters  as  it  desires.  For  example,  according  to  this 
tariff,32 

20-Mark  pieces  are  reckoned  as  .8992  fine 

Sovereigns  .9164 

Eagles  .8992 

Gold   coin  of   Austria,   Holland,  Scandinavia, 
and  Japan  .8992 

Thus  the  Bank  counts  foreign  coin  as  being  of  a  some- 
what lower  fineness  than  its  exact  legal  standard.  If  the 
Bank  should  go  too  far  in  making  this  tariff  unfavorable, 
the  owner  of  the  coin  could  pay  the  expenses  of  the 
melting  and  refining,  and  then  could  sell  his  gold  as  lino 
bars  at  the  fixed  legal  price.  The  following  is  self-ex- 
planatory: 

•'io  Cf.  E.  Kaufl'niann,  "Banknotes,  Monnaies  et  Arbitrages,"  p.  ::">s. 

-I  The  chief  forms  in  which  gold  appears  in  regular  international 
shipments  to-day  are  coin  and  "tine"  liars.  The  latter  are  usually 
as  high  or  higher  than  .9!)!)  in  fineness,  and  free  from  injurious 
impurities. 

32  Given  at  p.  41!)  in  Swoboda   (as  already  eited). 


512  FOREIGN  EXCHANGE 

SALE  OF  10.000  EAGLES  TO  THE  BANK 

10,000  Eagles  should  weigh  at  25.8  grains  per 

dollar  2,580,000  grains 

2,580,000  grains,  at  15,432  grains  per  kilo- 
gram, equal  167.185  kilograms 

Allowing  say  Mo  of  1%  weight  shortage,  this 

lot  of  eagles  should  weigh  167.018  kilograms 

167.018  kilograms  reckoned  as  .8992  fine  would 

have  a  fine  contents  of  150.183  kilograms 

150.183  kilograms  at  3,437  francs  per  kilogram, 

are  wortli  516,178.97  Francs 

10,000  eagles  are  $100,000.  If  $100,000  of  American  gold 
coin  produces  516,178.97  francs,  $1  produces  S.lG^ioo 
francs.  By  referring  to  the  table  on  page  485  we  see  that 
the  mint  par  between  the  United  States  and  France  is 
$l  =  5.182%oo  francs.  Therefore  in  case  of  actual  ship- 
ment and  sale  of  American  gold  coin  for  French  money, 
the  proceeds  per  dollar  turn  out  to  be  about  2  centimes 
under  the  mint  par.  This  loss  is  accounted  for  by  three 
factors,  namely,  (1)  the  charge  of  6.70  francs  per  standard 
kilogram  levied  by  the  French  mint  for  converting  any 
gold  into  French  coin,  (2)  the  reduction  of  the  rated  fine- 
ness of  American  coin  to  .8992  in  the  tariff  of  the  Bank 
of  France,  (this  signifying  a  loss  of  §4o  of  one  one-thou- 
sandth from  the  .900  of  fineness  assumed  in  calculating 
a  mint  par33),  and  (3)  the  loss  in  the  weight  of  gold  con- 
sequent (chiefly)  upon  taking  abraded  coin  from  circula- 
tion. 

The  Bank's  Terms  of  Payment  for  Gold. — The  Bank 
of  France  buys  gold  only  in  large  lots.  As  soon  as  the  value 
of  a  lot,  bars,  or  foreign  coin,  has  been  determined,  and 
the  gold  is  delivered  over  the  counters  of  the  Bank,  the 
institution  will  make  an  immediate  payment  of  95%   of 

33  See  the  definition  of  mint  part.  p.  432. 


MONETARY  SYSTEMS  OF  LEADING  NATIONS      513 

the  value  of  the  deposit  on  account.  The  Bank  treats 
this  partial  payment  as  an  "advance"  inasmuch  as  it 
itself  will  have  to  wait  until  the  bullion  has  been  coined 
at  the  mint  before  it  receives  back  the  coin  which  the 
metal  will  make.  On  the  actual  date  when  the  mint  de- 
livers up  this  coin  the  advance  is  regarded  as  terminating, 
and  the  remaining  5%  due  the  original  depositors  of  the 
bullion  or  foreign  coin  is  then  paid  him.  But  the  Bank 
charges  the  latter  interest  for  the  advance  it  has  made  him, 
practically  always  at  the  very  low  rate  of  1%  per  annum. 
This  interest  is  collected  under  the  following  rules.  At 
the  time  of  the  prepayment  of  the  95%,  the  Bank  with- 
holds interest  on  this  sum  for  36  days,  or  Mo  of  a  year, 
making  the  deduction  thus  regularly  Mo  of  1%.  Then 
when  the  advance  terminates  and  the  remaining  5%  of 
the  principal  amount  is  paid,  an  adjustment  is  made  so 
that  the  depositor's  real  interest  payment  will  be  only  for 
the  period  that  has  turned  out  to  be  the  actual  time  of  the 
advance.34 

§  134.  The  mint  and  bank  price  of  gold  in  Germany.35  — 
Since  the  German  law  provides  that  139/6  ten-mark  pieces 
shall  be  coined  from  1  pound  (i.e. — one-half  kilogram) 
of  fine  gold,  the  coining  value  of  the  kilogram  becomes 
2,790  Marks.  The  German  law  fixes  a  charge  for  coining, 
of  3  Marks  per  pound  of  fine  gold,  or  6  Marks  per  kilo- 
gram.    Consequently  we  obtain  the  following: 

Coining  value  of  1  kilogram  fine  gold  2,790  Marks 

Seigniorage  or  brassage  charge  per  kilogram  G 

Mint  Price  of  Gold,  per  fine  kilogram  2,784  Marks 

The  mint  price  for  standard  gold  is  simply  9io  of  2,784, 

3*  Compare  Swoboda,  "Die  Arbitrage"  (as  already  cited)  p.  421, 
and  Kauffmann's,  "Banknotes,"  etc.,  p.  359. 

*6The  information  given  in  this  section  applies  to  conditions  in 
Germany  prior  to  the  great  war. 


514  FOREIGN  EXCHANGE 

or  2505. GO  per  kilogram.88  The  mint  does  not  pay  the 
depositor  the  value  of  his  bullion  in  money  until  the  time 
actually  required  for  coinage  elapses.  To  be  receivable 
by  the  mint,  bars  must  have  a  minimum  weight  of  5  pounds 
(2%  kilograms)  and  be  of  a  minimum  fineness  of  .900, 
except  that  when  a  number  of  bars  are  offered  in  a  single 
deposit  it  suffices  for  them  to  have  an  average  fineness  of 
.900.  The  charge  for  assaying  is  3  Marks  per  bar.  When 
non-standard  bars  can  be  made  suitable  for  coining  by 
the  mere  addition  of  copper,  the  mint  price  for  the  pure 
gold  contents  of  these  bars  is  calculated  at  the  full  rate 
of  2,784  M  per  kilogram.  (That  is,  no  charge  is  made 
for  copper,  outside  of  the  "coining  charge"  of  6  Marks 
per  kilogram.) 

The  price  of  gold  at  the  Reichsbank.37  Gold  Bars. — 
The  Reichsbank  buys  gold  bars  on  the  following  terms. 
(1)  The  bars  must  weigh  at  least  2%  kilograms  each,  and 
must  possess  an  average  fineness  of  at  least  .900.  (2)  The 
fineness  must  be  tested  two  times  at  an  official  assay  office ; 
charges  3  M.  per  bar  for  the  two  tests.  (3)  When  the 
value  of  the  gold  is  thus  established,  the  Bank  pays  for  it 
cash  down  the  price  of  2,784  M.  per  fine  kilogram.  (4)  Bars 
with  a  fineness  certified  to  by  foreign  mints  or  official  as- 
saj'ers  are  sent  to  a  regular  German  assay  office  for  test, 
but  the  Bank  advances  %o  of  the  value  calculated  on  the 
basis  of  the  foreign  certification,  without  waiting  for  the 
returns  from  the  home  assay.  The  balance  in  full  is  paid 
at  the  time  of  the  receipt  of  these  returns  calculated  ac- 
cording to  them.     (5)    The  seller  of  bars  must  agree  to 

36  The  German  law  is  peculiar  in  that  it  specifies  how  many  money 
units  are  to  be  made  from  a  given  weight  of  fine  gold.  France, 
England,  and  the  United  States  define  their  money  units,  in  the 
statutory  law,  by  specifying  the  number  to  be  made  from  a  given 
weight  of  standard  gold,  or  else  by  giving  their  weight  in  standard 
gold. 

37  From  Swoboda    (as  already  cited),  p.  200. 


MONETARY  SYSTEMS  OF  LEADING  NATIONS      515 

take  back  any  that  are  subsequently  discovered  to  be  brittle 
or  to  contain  iridium,  and  to  return  the  price  paid  for 
them. 

Foreign  Gold  Coin. — The  Reichsbank  buys  foreign  gold 
coin  as  a  special  article,  without  the  requirement  that  it 
shall  be  melted  and  assayed,  paying  for  the  different  kinds 
prices  which  it  sets  forth  in  a  schedule  or  tariff.  The  fol- 
lowing items  are  selected  from  one  of  these  tariffs.38 

REICHSBANK'S  BUYING  PRICE  FOR  FOREIGN  COIN 
PER  KILOGRAM  OF  GROSS  WEIGHT 
(A  few  of  the  items  given  as  examples) 
Eagles  2,505.60    M.         (.900) 

20  Franc  pieces  of  the  Latin  Union 
countries,  and  certain  other  franc- 
coining  countries  (except  Greece)  2,504.208  M.  (.8995) 
10  and  5  Franc  pieces  of  France, 
Belgium,  and  Italy,  at  the  same  price 
with  a  deduction  of  %oooo  from  the 
gross  weight  as  an  allowance  for  dirt. 
Sovereigns  2,551.536  M.         (.9165) 

The  last  column  shows  the  fineness  of  the  respective 
pieces  implied  in  the  price  offered  by  the  Reichsbank.  To 
explain:  the  legal  standard  of  fineness  of  the  sovereign  is 
.916%,  but  on  account  of  the  "remedy"  or  tolerance  for 
error  in  minting,  a  given  lot  of  sovereigns  might  show  say 
an  average  fineness  of  .9165.  If  this  lot  were  melted  into 
a  bar  which  assayed  at  .9165,  and  this  bar  were  sold  at 
the  regular  mint  or  bank  price  of  2,784  M.  per  fine  kilo- 
gram, it  would  fetch  2,551.536  M.  per  gross  kilogram. 
Since  the  Bank  offers  just  2,551.536  M.  per  gross  kilogram 
for  sovereigns,  we  may  say  it  buys  sovereigns  on  the  basis 
of  a  fineness  of  .9165.89     It  is  a  point  of  interesl  thai  in  the 

88 Ab  given  by  Swoboda  (as  already  cited),  p.  204. 
■"">  In   making  this  calculation  the  assay  charges  incidental  to  (he 
sale  of  bar  gold  are  ignored. 


516  FOREIGN  EX  CHANGE 

tariff  from  which  the  above  excerpts  were  made,  United 
States  eagles  were  complimented  by  being  the  only  foreign 
coins  bought  on  the  basis  of  possessing  the  precise  degree 
of  fineness  established  for  them  by  law.  Dutch,  Austrian, 
and  Japanese  gold  coin  were  close  seconds,  since  with  a 
legal  fineness  of  .900  they  were  priced  as  if  .8999  fine. 


CHAPTER  XX 

SPECIE  SHIPMENTS 

§  135.  The  classification  of  gold  movements. — Four  types 
of  international  gold  movements  may  be  distinguished. 
(1)  First  there  is  the  export  and  import  of  gold  contained 
in  manufactured  articles,  jewelry,  and  like  objects  made 
partly  of  this  metal.  This  may  be  called  the  movement 
of  manufactured  gold.  This  movement  has  no  special  re- 
lation with  exchange  rates,  that  is,  it  has  just  the  same 
connections  with  these  rates  as  has  the  movement  of  all 
ordinary  commodities.  (2)  Second  there  is  the  flow  of 
new  gold  from  the  mines  to  the  general  market  of  the 
world.  This  is  in  large  part  an  international  movement 
because  it  happens  to-day  that  the  greater  portion  of  new 
gold  is  found  outside  the  main  zone  of  commerce  which 
contains  the  principal  gold-standard  countries.  And  most 
of  this  gold  is  shipped  into  these  countries  as  fast  as  pro- 
duced. This  flow,  the  movement  of  new  gold,  in  part  takes 
place  without  reference  to  the  position  of  the  international 
exchanges.  And  where  it  is  influenced  by  the  exchanges, 
and  in  turn  exercises  an  influence  upon  them,  the  char- 
acter of  this  influence  or  the  general  relation  of  this  gold 
movement  to  the  "balance  of  international  indebtedness," 
is  different  from  what  it  is  in  the  case  of  the  ordinary  or 
"commercial"  gold  movement.  (3)  In  the  third  place  we 
distinguish  gold  shipments  which  have  for  their  function 
the  mere  discharge  of  previously  created  indebtedness  be- 
tween one  gold-standard  country  and  another.  These 
shipments  are  due  to  the  condition  of  commerce  (using  the 

517 


518  FOREIGN  EXCHANGE 

term  in  its  broadest  sense)  as  it  works  out  its  effects 
through  its  influence  upon  the  market  for  foreign  exchange. 
This  class  of  gold  we  may  call  the  commercial  movenu  nt 
of  gold  between  gold-standard  countries.  It  is  with  this 
movement  that  the  present  chapter  has  to  deal.  (4) 
Fourthly  we  have  the  commercial  movement  of  gold  be- 
tween a  gold-standard  and  a  non-gold-standard  country, 
or  between  two  non-gold-standard  countries.  For  even 
countries  which  lack  a  gold-standard  ship  the  metal  in  and 
out,  at  least  as  one  means  of  settling  international  indebted- 
ness. This  class  of  shipments  resembles  the  third  in  cer- 
tain respects  but  also  lias  its  peculiar  features. 

§  136.  Gold  shipments  for  a  profit. — If  it  were  not  for 
the  intervention  of  bankers  and  exchange  dealers  as  mid- 
dlemen,1 merchants  and  other  foreign  debtors  and  creditors 
would  have  to  buy  and  sell  exchange  among  themselves, 
and  they  would  also  find  it  necessary  from  time  to  time 
to  make  international  shipments  of  gold  on  their  private 
and  individual  accounts.  For  when,  under  the  influence 
of  supply  and  demand,  the  price  of  exchange  should  mount 
above  a  certain  point,  those  owing  money  abroad  would 
find  it  cheaper  to  send  gold  than  to  buy  exchange;  and 
when  exchange  should  fall  below  a  certain  point,  those 
having  it  would  not  sell  but  would  obtain  better  returns 
by  sending  it  abroad  for  encashment  in  gold  to  be  brought 
back  and  converted  into  home  money.  Thus  there  would 
be  specie  shipments  without  bankers.  But  in  point  of 
fact  virtually  all  the  shipments  of  gold  that  answer  to 
the  ascent  and  descent  of  the  rates  of  exchange,  are  en- 
gineered by  bankers  alone.  Bankers  can  operate  at  a 
lower  incidental  expense  than  mere  merchants,  and  thus 
as  a  regular  thing  they  intervene  to  move  the  metal  be- 
fore the  rates  of  exchange  have  risen  or  fallen  far  enough 
to  make  it  a  business  possibility  for  a  merchant  to  ship  it. 

i  Compare  §21. 


SPECIE  SHIPMENTS  519 

Gold  shipment  amounts  to  a  species  of  relief  from  too 
high  or  too  low  a  swing  of  the  exchange  rates,  and  the  ac- 
tion of  bankers  affords  this  relief.  Nevertheless  if  the 
bankers  should  fail  to  supply  the  remedy,  merchants  them- 
selves would  find  it  necessary  to  act.  To  illustrate,  in 
New  York  in  1896,  a  pool  of  the  foreign-exchange  firms 
of  the  country  was  formed  to  aid  in  carrying  out  part  of 
the  program  of  the  famous  Morgan-Belmont  syndicate  to 
sustain  the  gold  reserves  in  the  United  States  Treasury. 
The  bankers  undertook  to  prevent  gold  exports.  In  the 
course  of  events  the  rate  for  sight  sterling  rose  to  $4.91 
per  pound.  Whereupon  a  coffee  importing  house  of  New 
York  began  to  export  gold,  sending  out  enough  in  fact 
not  only  to  satisfy  its  own  commitments,  but  to  establish 
a  foreign  credit  against  which  it  sold  exchange  to  others 
at  a  profit.  In  this  case  the  merchant  went  into  the  ex- 
change business.     The  bankers'  pool  soon  dissolved.2 

Those  gold  movements  then  which  take  place  in  answer 
to  the  fluctuations-  of  the  exchanges  are  engineered  by  the 
bankers.  And  when  they  occur  they  are  governed  in  the 
first  instance  or  proximately  by  the  position  of  the  rate 
for  bankers'  sight  drafts.  The  supply  of  and  demand  for 
commercial  bills,  or  the  market  rates  for  the  same,  are 
the  ch'ief  factors  governing  gold  movements  fundamentally 
and  in  the  long  run,  but  are  operative  only  through  their 
effect  upon  the  bankers'  sight  rate.  Assume  that  $4.8665 
of  United  States  gold  coin  exported  to  England  will  yield 
just  £1  of  British  money  after  arrival,  and  conversely  thai 
£1  shipped  from  England  will  produce  $-4.8665  in  America. 
Assume  also  that  the  total  of  incidental  expenses  for  gold 
export  as  conducted  by  a  New  York  bank  will  be  V^  and 
for  an   import   21i-(i   per   pound   sterling.     Tt    would    then 

2  This  remarkable  as  ociation  was  partly  successful  in  effecting  its 
chief  objects.  Its  monopolistic  high  rules  for  exchanges  were  rather 
an  incident  to  its  main  program  of  checking  gold  export. 


520  FOREIGN  EXCHANGE 

cosl  a  hanking  house  $4.8815  to  produce  a  pound  of  credit 
in  London  by  the  method  of  gold  export.  The  pound 
would  cost 

$4.8665  initial  outlay  in  U.  S.  money. 
.0150  total  incidental  expenses. 


$4.8815  entire  cost. 

The  consequence  of  this  would  be  that  in  times  of  un- 
hampered gold  movement  the  rate  for  bankers'  sight  drafts 
could  not  rise  to  anj^  great  distance  above  4.8815.  Two 
distinct,  though  related,  reasons  explain  this.  (1)  The 
demand  for  bankers'  sight  sterling  at  ordinary  rates  comes 
in  part  from  banks  which  possess  the  facilities  for  gold 
export.  This  demand  would  simply  cease  to  exist  at  any 
rate  appreciably  above  4.8815.  No  such  bank,  acting  as 
an  individual  institution  in  the  pursuit  of  its  own  profit,3 
could  be  expected  to  pay  say  4.8830  per  £  for  sight  bills 
to  create  a  fund  in  London  when  the  same  result  can  be 
accomplished  by  gold  shipment,  all  expenses  paid,  at 
4.8815  per  £.  Thus  the  disappearance  of  one  element  in 
the  demand  for  bills  as  soon  as  the  rate  passes  above  a 
certain  point  is  one  influence  which  tends  to  check  further 
rise.  However  the  demand  from  banks  which  do  not 
usually  ship  specie  and  the  demand  especially  from  non- 
banking  sources  would  continue  for  a  time.  (2)  But  in 
the  second  place  the  ascent  of  the  rate  an  appreciable 
distance  above  4.8815  opens  up  a  practically  inexhaustible 
supply  of  bankers'  sight  exchange,  and  this  serves,  in  and 
of  itself,  to  put  a  complete  check  upon  further  rise.  This 
supply  originates  in  the  export  of  gold  by  the  banks  for 
the  purpose  of  selling  exchange  at  a  profit.     Suppose  the 

3  Concerning  the  cases  where  gold  movements  seem  to  be  or  are 
independent  of  the  mere  private  profits  of  the  shipping  banks, 
see  §§  143-7. 


SPECIE  SHIPMENTS  521 

non-banking  demand  drives  the  rate  up  to  4.8825.  Then 
bankers  generally  will  begin  to  export  gold  and  produce 
a  pound  sterling  of  credit  abroad  at  a  cost  of  4.8815,  and 
at  the  same  time  sell  drafts  on  this  credit  at  4.8825,  mak- 
ing a  profit  of  10  "points"  or  Ko  cent  to  the  pound.  Per- 
haps not  all  banks  will  begin  at  precisely  the  same  point, 
but  there  will  soon  come  forth  a  supply  sufficient  to  check 
further  rise  of  exchange.  It  may  be  necessary  for  the 
shipments  to  continue  more  or  less  steadily  through  weeks 
or  even  months  before  the  forces  which  tend  to  drive  rates 
higher  exhaust  themselves.  Such  an  outpouring  of  gold- 
export  bills  would  be  stopped  by  the  breakdown  or  sus- 
pension of  the  gold  standard,  but  in  the  case  of  the  lead- 
ing countries,  before  the  war,  the  yielding  of  a  small  frac- 
tion of  the  entire  stock  of  gold  would  always  suffice.  Dur- 
ing hostilities  the  governments  of  all  the  belligerent  and 
of  most  if  not  all  neutral  states  of  consequence,  took  con- 
trol of  the  outshipment  of  gold. 

Turning  now  to  the  relation  of  gold  imports  to  the  rate 
for  bankers'  sight  drafts,  our  present  assumption  is  that 
a  pound  of  English  gold  coin  transported  to  the  United 
States,  at  an  expense  to  any  of  our  banks  of  2li><^,  will 
produce  $4.8665.  The  net  proceeds  of  the  import  of  a 
pound  will  then  be  $4.8415  (that  is,  4.8665- .025).  From 
this  it  follows  that  in  ordinary  times  the  price  for  bank- 
ers' sight  drafts  on  London  cannot  fall  very  far  below 
$4.8415.  The  great  influence  acting  to  check  further  de- 
cline will  be  the  emergence  of  an  indefinitely  large  demand 
for  these  bills,  a  demand  coming  from  banks  with  facilities 
for  gold  import.  If  the  rate  falls  to  4.84  for  instance, 
a  bank  will  make  1^/ioo  of  1^  on  every  pound  of  bill  that  it 
purchases  on  this  side  and  uses  as  a  means  of  importing 
gold.  It  is  true  the  specie  cannot  arrive  until  from  12 
to  20  days  after  the  purchase  of  the  bills,  and  there  is 
therefore  an  interest  loss  or  cost  in  the  transaction  of  gold 


FOREIGN  EXCHANGE 

importation,  but  this  interest  charge  is  included  in  the 
L'^.r  which  we  have  assumed  for  the  presenl  to  be  the  costs 
of  the  import  of  £1  of  gold.  The  account  of  the  venture 
would  therefore  stand  as  follows: 

U.  S.  money  realized  on  each  £  of  imported  gold.  .$4.8665 
Expenses  per  £   (including  interest)    0250 

Net  proceeds  from  each  £ 4.8415 

Cost  of  each  £  in  purchase  of  bill 4.8400 

Profit  per  £  (about  %2%)   $  .0015 

The  foregoing  explanation  as  a  whole  should  make  it  clear 
why  gold  export  and  import  under  normal  and  competi- 
tive conditions  make  it  impossible  for  the  bankers'  sight 
rate  to  swing  beyond  certain  very  definite  limits.  As  a 
general  thing  before  the  war,  these  limits  stood  in  the 
case  of  the  New  York  rate  for  sterling  exchange,  at  about 
4.88  and  4.84,  and  the  range  of  fluctuation  between  them 
was  something  less  than  1%  of  the  mint  par. 

§  137.  The  gold  points. — The  rates  of  exchange  at  which 
gold  movements  take  place  are  known  as  the  "gold  points." 
The  terms  "export  point"  and  "import  point"  are  self- 
explanatory.  But  it  is  not  to  be  understood  that  these  are 
really  invariable  or  precise  points.  "When  under  given 
conditions  sight  sterling  reaches  say  4.8770  gold  exports 
may  begin  to  move  without  at  first  taking  place  in  great 
volume.  The  influences  which  are  making  for  dear  ex- 
change may  perhaps  force  the  rate  on  up  to  4.8790  be- 
fore the  full  flow  of  gold  appears  which  is  sufficient  wholly 
to  check  further  rise.  Thus  it  would  be  more  accurate  to 
say  that  at  this  time  there  is  a  gold  export  region  in  the 
rate,  namely  4.8770  to  4.8790,  rather  than  a  precise 
"point."  The  exact  cost  of  shipment  is  perhaps  slightly 
different  for  different  banks.  The  disposition  of  banks 
to  move  gold  probably  is  influenced  to  an  extent  by  their 


SPECIE  SHIPMENTS  523 

estimates  of  the  ulterior  effects  of  the  movement  upon 
money  market  conditions,  or  upon  sentiment.  It  is  sup- 
posed that  the  stock  market  effect  of  a  gold  movement  is 
sometimes  taken  into  view  as  a  matter  of  considerable 
consequence.  Thus  at  times  part  of  the  banks  or  all  of 
them  may  refrain  from  moving  gold  unless  a  considerable 
gain  will  appear  in  the  transaction,  whereas  at  other 
times  they  might  be  content  with  an  exceedingly  small 
profit. 

In  the  month  of  April,  1906,  gold  imports  into  New 
York  were  delayed  to  such  an  extent  that  sight  sterling 
reached  on  the  eleventh  so  low  a  point  as  4.8290.  Again 
on  December  7,  1903,  it  fell  to  4.8275.  The  latter  was 
the  lowest  rate  experienced  in  New  York  in  thirteen 
years.  4  Yet  on  September  12,  1905,  New  York  engaged 
$1,250,000  worth  of  gold  in  London  for  import  with  sight 
sterling  as  high  as  4.85.5  Among  the  causes  for  the  dif- 
ference in  location  of  the  gold  points  at  different  times 
we  may  mention  the  following.  (1)  Changes  in  the  price 
of  gold.  These  changes  may  affect  both  the  initial  out- 
lay and  the  proceeds  in  a  gold  shipment.  It  should  be 
stated,  however,  that  so  far  as  American  gold  movements 
are  concerned,  there  is  almost  no  fluctuation  in  the  pur- 
chase or  sale  price  of  gold  on  this  side  of  the  water.  But 
in  the  European  countries  these  prices  change  enough  to 
work  a  considerable  effect  upon  the  gold  movement.  (2) 
The  incidental  expenses  of  moving  gold  also  vary  some- 
what as  between  different  times.  Interest  is  one  element 
in  these  charges  which  is  always  a  variable.  Freighl  and 
insurance  costs  also  change  sometimes,  but  war-times  aside, 
not  so  often  nor  to  so  great  an  extent. 

§  138.  Gold  export,  New  York  to  London :  practical  com- 

■i  Sir  the  Commercial  and  Financial  Chronicle  for  April  14,  1906, 
p.  833. 

5See  the  Wall  Street  Journal   for  Sept.    It.   1905,  p.  8. 


524  FOREIGN  EXCHANGE 

putations. — Coming  now  to  the  practical  calculation  of 
the  costs  and  proceeds  of  gold  shipments,  we  shall  con- 
sider first  an  export  of  coin  from  New  York  to  London. 

Example  1 
An  Export  of  U.  S.  Coin  from  New  York  to  London 
(Bank  of  England  buying  Eagles  at  76s.  4d.  per  oz.) 

INITIAL    OUTLAY 

$1,000,000  of  current  gold  coin  $1,000,000 

Full  legal   weight    (1,000,000X25.8  grains)  = 

25,800,000  grains,  or  53,750  ounces,  .900  fine. 

Actual    weight    on    arrival    is    say    53,715 

ounces,  showing  a  shortage  due  to  all  causes 

of  35  oz.  or  nearly  %5  of  1%. 

INCIDENTAL   EXPENSES 

Packing  and  cartage  60 

20  kegs  of  $50,000  each 
(Packing  $2  per  keg) 
(Cartage  $1  per  keg) 
Freight   (at  rate  of  %6  of  1%  of  the  value)   in- 
cluding delivery  to  designated  party  in  London . . .  1,875 

Insurance  (Y20  of  1%  of  value)   500 

Interest   (none  charged  in  this  case,  but  see  text 

below)  

Total  outlay   $1,002,435 

PROCEEDS 

53,715  oz.  of  U.  S.  gold  coin, 
sold  as  such  to  Bank  of  England  at  76s.  4d. 
per  oz.  gross  weight.     76s.  4d.  =  916d. 

(916d.  X  53,715  =  49,202,940d.)  or  £205,012 

Commissions  or  Expenses  Abroad. 

A  gratuity  of  £2  to  Bank  of  England  messenger.  2 

Between  regular  correspondents  no  commissions 
are  asked. 


Net  proceeds    £205,010 


SPECIE  SHIPMENTS  525 

COST  IN  DOLLARS  OP  £1  OF  CREDIT  PRODUCED  ABROAD. 

If  £205,010  cost  $1,002,435 

£1  costs  (1,002,435  -r-  205,010)   $4.8897 

or 

NO-PROFIT  GOLD-EXPORT   POINT    4.8897 

A  comparison  of  the  net  proceeds  abroad  in  pounds,  with 
the  total  outlay  at  home  in  dollars,  shows  that  the  cost 
of  each  £1  of  foreign  credit  is  $4.8897.     As  indicated  we 
may  call  this,  under  the  conditions,  the  "no-profit  gold- 
export  point."     A  gold  point  is  a  point  or  figure  in  the 
exchange  rate  at  which  we  may  expect  a  gold  movement 
to  be  induced.     By  a  no-profit  gold  point  we  mean  the  rate 
at  which  gold  might  be  moved  without  the  shipper  mak- 
ing either  profit  or  loss.     Thus  under  the  conditions  of 
our  present  example,  if  a  banker  exported  $1,000,000  of 
American  coin,  at  an  incidental  expense  of  $2,435,  and  in 
this  manner  produced  a  credit  in  London  of  £205,010,  and 
sold  £205,010  of  his  demand  drafts  against  this  credit  at 
the  rate  of  $4.8897 ;  he  would  come  out  exactly  even.     His 
total  outlay  in  the  venture  would  be  $1,002,435,  and  his 
Total  return  would  be  205,010  X  4.8897  or  $1,002,435.     Of 
course  it  is  not  at  this  so-called  no-profit  point  that  we 
would    expect   shipment   actually   to   take   place.     If   the 
bank  should  defer  export  until  it  could  make  certain  of 
selling  its  drafts  at  a  higher  figure,  as  say  4.8915,  it  would 
then  make  a  profit  of  $.0018  per  pound,  or  a  total  profit 
of  $369.01  or    (205,010  X  .0018).     As  we  shall  see,  it  is 
possible   also   to    calculate    no-profit   import    points.     The 
reason   for  distinguishing  the   no-profit    from   the    actual 
points,  is  that  under  given  conditions  and  with  a   given 
sort  of  gold  to  ship,  the  former  are  precise  and  definite 
figures,  whereas  the  actual  gold  points,  differing  as  they 
do  from  the  no-profit  points  by  the  margin   of  gain   re- 
quired to  induce  banks  to  make  shipments,  are  a  little  less 
definite.     Special    circumstances    apart,    it    may    be    said 


:>-2C>  FOREIGN  EXCHANGE 

banks  do  not  care  to  move  gold  for  a  profit  of  less  than 
M-2  of  1%,  which  means  almost  exactly  15  points,  or  l9ioo 
of  1(*  per  pound.  This  signifies  then  that  the  actual  or 
ordinary-profit  gold  export  point  should  stand  about  15 
points  above  the  calculated  no-profit  export  point,  and  the 
actual  import  point  about  15  points  below  the  no-profit 
import  point. 

In  the  foregoing  calculation  we  made  an  allowance  of 
Ms  of  1%  for  deficiency  in  the  weight  of  the  gold  coin 
exported.  It  will  of  course  pay  an  exporter  to  obtain 
as  heavy  coin  as  possible,  but  the  precise  percentage  of 
deficiency  in  weight  is  naturally  as  variable  as  between 
different  shipments.  The  less  this  deficiency  the  lower  the 
no-profit  export  point  will  be,  because  the  greater  will 
be  the  sterling  proceeds  of  the  export.  And  the  greater 
these  proceeds  for  a  given  outlay  at  home  in  dollars,  the 
less  the  number  of  the  dollars  of  outlay  will  be  per  pound 
of  proceeds.  Thus  the  4.8897  no-profit  point  of  our  ex- 
ample would  become  4.8865  if  the  coin  were  absolutely 
full  weight. 

A  gold  export  is  a  business  transaction  involving  a 
money  outlay  and  a  money  return.  The  main  outlay  is 
made  on  the  day  when  the  gold  is  withdrawn  from  the 
general  resources  of  the  bank  while  the  return  is  realized 
on  the  day  when  payment  is  received  for  the  exchange 
which  is  sold  against  the  export.  If  outlay  and  return  oc- 
cur on  the  same  day,  the  transaction  is  not  chargeable 
with  an  expense  for  interest.  If  on  the  other  hand  three 
days,  say,  should  intervene  between  outlay  and  return,  a 
charge  of  three  days  interest — at  the  home  market  rate 
of  interest — is  to  be  reckoned  against  the  operation.  In 
the  example  under  consideration  three  days  interest  at 
4.-%  would  amount  to  $334.15.  The  interest  charge  is 
omitted  in  our  calculation  not  on  the  grounds  that  it  is 
negligible  when  it  exists,  but  because  it  is  a  variable  de- 


SPECIE  SHIPMENTS  527 

pendent  upon  minor  circumstances  attending  the  ship- 
ment. It  readily  appears  an  allowance  for  an  interest 
cost  will  raise  the  "no-profit  gold  export  point."  When 
circumstances  favor  the  transaction  loss  of  interest  may 
be  avoided.  Quoting  a  letter  from  a  gentleman  in  the  bank- 
ing business,  "In  actual  business  there  is  usually  from 
one  to  three  days  loss  of  interest.  For  example,  if  a 
steamer  sails  Saturday  at  10  a.  m.,  the  gold  must  be  taken 
out  and  paid  for  on  Friday,  while  the  bill  of  exchange 
is  sold  under  contract  for  Saturday's  steamer  and  paid 
for  on  that  day.  Now  if  this  latter  transaction  is  settled 
for  in  gold,  there  would  be  a  loss  in  interest  of  one  day; 
but  according  to  custom  the  bill  of  exchange  is  paid  for 
by  a  draft  on  some  Clearing  House  institution,  which 
must  be  presented  for  payment  through  the  Clearing 
House  on  Monday;  so  actually  you  would  get  payment 
for  the  bill  of  exchange  in  gold  three  days  after  you 
made  the  payment  for  the  shipment.  On  the  other 
hand,  should  the  steamer  sail  at  4  o'clock  in  the  after- 
noon and  dock  on  the  other  side  before  10  a.  m.  there 
would  be  time  to  clear  the  transaction  during  banking 
hours,  both  here  and  abroad,  which  would  cause  no  loss 
of  interest.  We  always  take  into  consideration  the  ac- 
tual conditions  at  the  time  the  shipment  is  made."6 

Example  2 
Another  Export  of  Coin — with  a  Higher  Price  for  Eagles 

(If  the  Bank  of  England  should  raise  its  price  for  U.  S.  gold 
coin  to  76s.  6'd.  per  ounce,  the  following  calculation  would 
hold)  : 

initial  outlay  (as  before) 

incidental  bxpenses  (as  before) 

Total    $1,002,435 

''•This  information  the  author  owes  to  the  kindness  "f  Mr.  <;.  E. 
Gregory  of  the  National  City  Bank  tA  New  5Tork.    The  freight,  In 


528  FOREIGN  EXCHANGE 

PROrEEDS 

53,715  oz.  of  U.  S.  gold  coin  sold  to  Bank  of 
England  (3    76s.  6d.  per  ounce  gross  weight 

(918d.  X  53,715  =  49,310,370d.)    or    £205,4597/8 

Less  sterling  expense   2 

Net   proceeds    £205,458 

NO-PROFIT  GOLD  EXPORT  POINT 4.8790 

(1,002,435  -r-  205,458) 

This  example  illustrates  the  fact  that  the  higher  the  price 
of  eagles  abroad,  the  greater  are  the  sterling  proceeds  of 
export  per  dollar  of  outlay,  and  the  lower  is  the  export 
point.  If  the  English  price  of  eagles  ascends  from  76s.  4d. 
(first  example)  to  76s.  7d.  per  ounce  (second  example), 
the  gold  point  descends  from  4.8897  to  4.8790,  or  more 
than  1^. 

The  "fine  bars"  which  the  New  York  Assay  Office  sells 
at  a  premium  of  40^  per  $1,000,  or  %s  of  1%,  are  the 
cheapest  and  best  form  of  gold  for  export  from  New  York.7 
They  are  always  used  in  preference  to  coin  to  export  to 
Europe  when  a  supply  of  them  is  available.  At  times  the 
demand  for  gold  for  export  will  temporarily  outrun  the 
New  York  supply  of  bars  and  in  these  cases  coin  may  be 
shipped  to  Europe,  even  in  large  quantities. 

Example  3 
An  Export  of  Fine  Bars  from  New  York  to  London. 
(Bars    sold   to    Bank   of    England    at   its   minimum   price   of 
£3  17s.  9d.  per  oz.  .916%  fine.) 

surance,  and  cartage  rates  used  in  the  calculations  in  the  text,  are 
those  given  by  Mr.  Gregory  as  being  in  force  shortly  before  the  war 
began.     Mr.    Gregory    states   that   a   bank   would    hardly   expect   to 
move  gold  for  a  profit  of  less  than  Vz2  of  1%. 
i  Compare  §  130. 


i 


SPECIE  SHIPMENTS  529 

INITIAL  OUTLAY 

Invested  in  assay  bars,  say,  .999  fine  with  a  con- 
tents of  48,375  oz.  of  fine  gold,  at  $20.67183  per 
oz.  fine  $1,000,000 

Plus  premium  of  40tf  per  $1,000 400 

$1,000,400 

INCIDENTAL   EXPENSES 

Packing  and  carting 60 

Freight  (9io  of  1%)   1,875 

Insurance  (%o  of  1% )   500 

Total  outlay   $1,002,835 

PROCEEDS 

48,375  oz.  of  fine  gold  make  52,772.727  (%  of 
48,375)  oz.  of  gold  x¥\2  fine;  counted  to  nearest 
Moth  oz.  below  as  52,772.725  or  52,7722%o  oz. 
at  the  Bank, 

bought  @  £3  17s.  9d.  per  oz £205,153.96% 

Less  minor  expense  2. 

£205,152. 

NO-PROFIT    EXPORT    POINT    $4.8882 

(1,002,835  -^205,152) 

Example  4 

the  same — with  a  higher  price  for  bars. 

(Bars  sold   to   the  Bank  of   England   at  the  relatively  high 

[though  not  the  highest]  price  of  £3  17s.  lOV-jd.) 
total  outlay,  the  same  as  before  $1,002,835 

PROCEEDS 

48,375   oz.   of  fine   gold,   making  52,7722%o   oz.   of 
standard  gold    (.916%  fine)    @  £3  17s.   10V2d.) 

per  oz £205,483.89 

Less  minor  expense 2. 

£205,482. 

no-profit  export  point $  1.880-1 

(1,002.835  -h  205,482) 


o30  FOREIGN  EXCHANGE 

Example  5 

the   same — With   Bars   Sold  in  the  Market  at  the  Extreme 
price  of  £3  18s.  0V2d. 

PROCEEDS 

52,7722%o  oz.  @  £3  18s.  Oy2d £205,923.57 

Less  minor  expense 2.00 

£205,921.00 
"no-profit  gold-point" 
1,002,835 -t- 205,921  =  4.8699   or   $4.8700 

This  gives  us  the  extreme  minimum  point  of  normal  times, 
and  if  a  shipment  incurs  an  interest  charge  the  point  can- 
not fall  quite  so  low  as  this.  On  October  24,  1904,  the 
New  York  Financier  reported  as  a  matter  of  interest  that 
owing  to  the  exceptionally  high  price  then  being  offered 
in  London  for  gold  bars,  the  export  point  lay  between 
4.87  and  4.871/4.8  A  comparison  of  the  five  preceding  ex- 
amples gives  us  the  following : 

Comparative  Table  of  No-Profit  Gold  Export  Points 
(In  the  rate  for  demand  sterling) 

1.  Export   of  coin    (M.5   of  1%   short  weight)    price  of 

eagles  at  £3  16s.  4d 4.8897 

2.  Export  of  bars,  price  £3  16s.  4d.  per  ounce,  .916%  fine.  4.8882 
3  Export  of  bars,  price  £3  17s.  10y2d 4.8804 

4.  Export   of   coin    {V15   of   1%    short   weight)    price   of 

eagles  at  £3  16s.  6d 4.8790 

5.  Export  of  bars,  price  £3  18s.  0y2d 4.8700 

As  already  said,  we  should  assume  that  banks  must  or- 
dinarily obtain  a  profit  of  Vs&  of  1%  before  they  will  un- 
dertake specie  shipments,  and  therefore  without  regard 
to  possible  interest  charges  we  should  add  ^oo  of  1$  to 
each  of  the  above  rates  to  find  the  actual  rates  at  which 
export  may  be  expected  to  take  place. 

*The  number  for  October  24,  1904,  p.  2,002. 


SPECIE  SHIPMENTS  531 

§  139.  Gold   import   by   New   York   from   London. — Our 

next  task  is  to  calculate  the  " no-profit  gold  import  point" 
in  the  rate  for  bankers'  sight  sterling.  We  treated  the 
complete  transaction  of  gold  export  as  consisting  in  two 
parts,  (1)  the  shipment  of  the  specie  itself  and  (2)  the 
sale  of  bankers'  sight  exchange  as  a  means  of  realizing 
on  the  shipment.  It  is  true  a  gold  export  might  take 
place  without  an  accompanying  sale  of  exchange  but  what 
we  may  well  call  the  standard  operation  of  gold  export 
is  completed  in  these  two  steps.  In  a  similar  way,  the 
standard  operation  of  gold  import  consists  in  two  parts, 
(1)  the  purchase  of  exchange  as  a  means  of  obtaining  the 
gold  abroad,  and  (2)  the  inshipment  of  the  specie  itself. 
In  the  illustration  to  follow  of  gold  import  by  New 
York,  we  shall  assume  that  "fine"  bars  can  be  procured 
in  the  London  market  at  the  price  of  £3  17s.  lOd.  The 
reader  will  understand,  of  course,  that  besides  bars,  Brit- 
ish gold  coin  can  always  and  American  gold  coin  can 
generally  be  obtained.  We  shall  suppose  the  importer  to 
deal  with  approximately  $1,000,000  of  bars. 

Example  6 

An  Import  of  Gold  Bars  by  New  York  from  London  Against  a 
Purchase  of  Sight  Drafts 

(Bars  being  procurable  in  the  London  market  @  £3  17s.  lOd.) 

INITIAL   OUTLAY    IN    LONDON 

Purchase  of  "fine"  bars  (say  .999)  which  have  a 
contents  of  48,400  oz.  of  pure  gold,  at  a  rate  of 
£3  17s.  lOd.  per  standard-oz.  of  contents £205,480. 

INCIDENTAL   EXPENSES   PAID   IN   LONDON 

Packing  and  cartage 10. 

Freight  (Wo  of  1%  of  value)    385. 

Insurance  (lAo  of  1%  of  value) 102. 

Total  sterling  outlay £205,977. 


532  FOKKIGN  EXCHANGE 

PROCEEDS   ON    ARRIVAL    IN    NEW   YORK 

48,400  oz.  fine  gold  sold  N.  Y.  Assay  Office  @ 

$20.67183  per  fine  oz $1,000,516.57 

Less  charge  for  copper 106.57 

[There  are  no  other  charges  for  this  kind  of 
gold.0] 

Net  proceeds  on  arrival $1,000,410.00 

THE   INTEREST   COST 

Deduct  20  days'  interest  at  N.  Y.  market  rate, 
say  4%    2,218. 

PRESENT   WORTH   OP  THE  PROCEEDS $998,192. 

That  is,  present  worth  at  the  time  when  the  sight 
exchange  was  bought,  or  20  days  before  gold 
arrives  and  proceeds  are  obtained. 

NO-PROFIT  PURCHASE  PRICE  FOR  SIGHT  DRAFTS,  OR  NO-PROFIT  IM- 
PORT  POINT 

$998,192  obtained  for  £205,977  of  drafts  bought,  which 
means  $4.8461  {i.e.,  998,192-^205,977)  obtained 
for  £1  of  draft  bought $4.8461 

Before  proceeding  to  the  necessary  explanations  of  the  items 
in  this  calculation,  we  had  best  give  two  more  examples. 

Example  7 
The  Same  Import — Except  against  a  Purchase  of  Cables 

NET   PROCEEDS   ON   ARRIVAL   IN  NEW  YORK $1,000,410 

[The  same  as  in  Example  6.] 

THE   INTEREST   COST 

10  days'  interest  @  4%. 

[10  instead  of  20  days] 1,110 

PRESENT    WORTH   OF   THE   PROCEEDS    $999,300 

»  Compare  §  130. 


SPECIE  SHIPMENTS  533 

That  is,  at  the  time  when  the  cable  transfer  was 
bought,  10  days  before  gold  arrives  and  proceeds 
are  obtained. 

NO-PROFIT    PURCHASE    PRICE    FOR    CABLES,    OR    NO-PKOFIT    IMPORT 
POINT   IN    CABLE   RATE 

(999,300-^205,977)    $4.8515 

Example  8 
An  Import  of  U.  S.  Gold  Coin  by  New  York  from  London 
(Bank  of  England  selling  Eagles  at  say  76s.  7d.  per  oz.) 

INITIAL  OUTLAY  IN  LONDON 

$1,000,000  of  U.  S.  gold  coin  bought  from  Bank 

of  England  for  76s.  7d.  per  oz.,  actual  weight, 

say,  53,715  oz.    (i.e.,  Viz  of  1%    under  legal 

weight) 

53,715  oz.  @  76s.  7d £205,683.+ 

INCIDENTAL    EXPENSES   PAID    IN    LONDON 

Packing  and  cartage 10. 

Freight  (Mb  of  1%  of  value) 385. 

Insurance  (%o  of  1% )   102. 

Total  sterling  outlay £206,180. 

PROCEEDS   ON   ARRIVAL   IN   NEW  YORK 

$1,000,000  of  home  coin  $1,000,000. 

THE    INTEREST    COST 

20  days'  interest  at  4%  2,217. 

PRESENT  WORTH  OF  THE   PROCEEDS $     997,783. 

As  explained  in  Example  6. 

NO-PROFIT   PURCHASE    PRICE   FOR    SIGHT    DRAFTS $4.8394 

(997,783 -=-206,180.) 


THE   NO-PROFIT  PRICE   FOR   CABLES   WOULD  BE $4.8447 

(Taking  10  clays'  interest,  c£.  Example  7) 
(998,891-^206,180) 


534  FOREIGN  EXCHANGE 

An  export  of  gold  against  a  sale  of  cables  is  not  a  simple 
or  standard  operation  because  it  would  either  involve  an 
overdraft  or  loan  in  London  for  the  period  which  must 
elapse  between  the  arrival  of  the  cable  draft  and  the  sub- 
sequent arrival  of  the  gold  credit,  or  would  necessitate  a 
delay  of  say  5  to  10  days  before  the  cables  could  be  sold. 
If  the  sale  of  cables  were  withheld  until  the  gold  credit 
should  be  established  abroad,  a  speculation  on  the  course 
of  cables  would  be  involved.  Since  there  would  have  to 
be  some  special  reason  for  selling  cables  later  rather  than 
selling  demand  bills  immediately,  an  export  of  gold  against 
a  sale  of  cables  should  not  be  considered  a  standard  op- 
eration. But  the  operation  of  an  import  of  gold  against  a 
purchase  of  cables  (as  a  means  of  procuring  the  foreign 
gold)  is  simple  or  standard.  If  cable  transfers  for 
£206,180  are  bought  in  New  York  to-day,  they  establish 
a  credit  in  London  to-day  or  to-morrow  and  this  credit 
may  be  converted  into  gold  forthwith  which  is  due  to 
arrive  in  New  York  in  10  days  or  less  from  to-day.  If 
sight  drafts  for  £206,180  are  bought  to-day,  we  must  al- 
low say  10  days  for  the  drafts  to  reach  London  and  10 
days  more  for  the  gold  to  get  back  to  New  York,  or  a 
total  of  20  days.  Ten  days  is  a  liberal  allowance  for  the 
transatlantic  mail  and  express,  and  frequently  the  cable 
and  sight  draft  operations  of  our  illustration  can  be 
brought  to  conclusion  in  shorter  periods  than  we  have 
assumed. 

A  banker  will  of  course  figure  the  interest  costs  on 
the  basis  of  the  actual  time  elapsed  between  investment  in 
exchange  and  realization  on  the  gold,  a  period  depending 
on  circumstances. 

Before  giving  further  attention  to  the  interest  cost 
chargeable  against  gold  movements,  we  may  put  together 
from  the  foregoing  tables  a  summary  of  gold  import 
points. 


SPECIE  SHIPMENTS  535 

Summary  of  Gold  Import  Points  as  Shown  in  the  Particular 
Examples  Preceding  10 

No-Profit  Ordinary  Profit 
Demand  Drafts                         Point  Point 

Import  of  bars  costing  £3  17s.  lOd. . .     4.8461  4.8445 

Import     of     U.      S.     coin      costing 

76s.  6d.  per  oz 4.8394  4.8380 

Cables 

Import  of  bars  as  above 4.8515  4.8500 

Import  of  coin  as  above 4.8447  4.8430 

To  show  how  an  importing  bank  makes  a  profit,  let  us 
assume  that  under  the  conditions  of  Example  6,  a  bank 
is  able  to  buy  £205,977  of  sight  drafts  in  New  York  at 
4.8445,  16  points  under  the  "no-profit"  import  point. 
The  drafts  will  cost  a  total  of  $997,855.  Mailing  these 
drafts  abroad,  the  bank  engages  gold  for  import.  It  thus 
procures  48,400  ounces  of  fine  gold  expenses  of  delivery 
in  New  York  prepaid.  This  bullion  arrives  20  days  after 
the  purchase  of  the  £205,977  of  drafts,  and  yields  net  pro- 
ceeds of  $1,000,410  by  sale  to  the  New  York  Assay  Office. 
The  net  proceeds  exceed  the  outlay  by  $2,555  (1,000,410- 
997,855).  From  these  gross  profits  substantially  $2,218 
must  be  deducted  for  interest  lost  (that  is,  foregone)  at 
the  New  York  market  rate  of  4%.  This  leaves  a  profit  of 
$337,  which  is  a  little  more  than  %2  of  1%  on  the  original 
outlay. 

In  engaging  gold  in  London  for  import,  the  decision 
whether  bars  or  coin  should  be  obtained  depends  simply 
upon  the  relative  prices  existing  at  the  time  for  these 
forms  of  gold.  Wbeilier  demand  sterling  or  cables  should 
be  purchased  on  this  side  as  the  means  of  procuring  the 

io  With  the  particular  rate  of  interest  assumed  in  these  examples 
the  difference  between  11i<'  cable  and  the  Bight  rate  import  points  will 
be  affected  by  a  change  in  the  interest  rate. 


53(i  FOREIGN  EXCHANGE 

gold  abroad,  depends  upon  the  space  or  "spread"  between 
the  demand  and  cable  rates.  The  cable  operation  involves 
roughly  about  half  as  much  loss  of  interest  as  the  oper- 
ation with  demand  drafts,  but  cables  will  ordinarily  cost 
about  enough  more  to  compensate  for  this.  It  is  generally 
understood  that  in  practice  the  greater  part  of  New  York's 
gold  imports  are  provided  for  by  the  purchase  of  demand 
drafts  rather  than  cables. 

§  140.  The  place  of  interest  in  the  cost  of  gold  movements. 
— Any  kind  of  business  transactions  involving  an  outlay 
of  money  (or  its  equivalent)  and  a  subsequent  return,  is 
chargeable  with  interest  for  the  time  running  between 
the  outlay  and  return.  If  the  return  exceeds  the  outlay 
merely  by  an  amount  equal  to  interest,  the  transaction 
results  neither  in  profit  nor  loss.  This  is  but  another  way 
of  saying  that  the  return  just  equals  the  "costs."  Gold 
export  against  a  sale  of  demand  drafts  involves  no  interest 
cost  if  incidental  circumstances  are  the  most  favorable 
possible,  because  the  return  from  the  sale  of  drafts  may  be 
had  on  the  same  day  with  the  outlay  for  gold.  But,  as 
already  explained,  more  frequently  from  one  to  three  days 
elapse  between  the  payment  for  the  gold  and  the  receipt 
of  money  for  the  drafts.  The  true  interest  charge  depends 
simply  on  the  actual  loss  of  time  experienced.  As  far  as 
the  time  consumed  in  the  transatlantic  passage  is  con- 
cerned, the  gold,  which  will  be  credited  to  the  account  of 
the  New  York  exporting  bank,  travels  just  as  fast  as  the 
drafts  which  will  be  debited.  Gold  import  against  a  pur- 
chase of  exchange  in  the  home  market  always  involves  an 
interest  cost.  In  what  we  have  called  the  "standard"  op- 
eration of  gold  import,  as  considered  in  the  preceding 
pages,  the  exchange  is  first  purchased  and  remitted  abroad 
for  conversion  into  gold.  The  latter  is  then  shipped  home. 
Thus  a  time  must  always  elapse  between  outlay  and  re- 
turn. 


SPECIE  SHIPMENTS  537 

The  problem  of  the  interest  charge  against  gold  move- 
ments presents  certain  curious  aspects  that  require  ex- 
amination to  safeguard  us  against  confusion.  A  gold  ship- 
ment from  London  to  New  York  may  show  at  least  three 
different  interest  costs,  depending  upon  the  manner  in 
which  the  shipment  is  engineered. 

The  practical  interest  charge  on  a  gold  shipment  from  London  to 

New  York 

(1)  On  the  basis  of  N.  Y.  rates  for  sterling. 

(a)  Against  purchase  of  demand  drafts.  .12-20  days'  interest 

(b)  Against  purchase  of  cables 7-10  days'  interest 

(2)  On  the  basis  of  London  rates  for  New 

York  exchange  u 

(c)  Against  a  sale  of  N.  Y.  drafts 0-3  days'  interest 

In  all  three  cases,  is  not  the  gold  locked  up  in  the  steam- 
er's express  room  for  the  same  length  of  time?  Since 
during  a  period  of,  say,  10  days  the  gold  can  serve  as 
bank  reserve  on  neither  side  of  the  water,  is  not  the  real 
interest  loss  necessarily  one  for  just  10  days  in  all  three 
cases? 

"We  might  have  knowledge  that  a  consignment  of  20 
kegs  of  gold  is  upon  a  transatlantic  steamer  westward 
bound,  and  that  this  metal  will  be  locked  up  10  days,  but 
we  could  not  tell  whether  the  bank  making  the  shipment 
is  charging  its  venture  with  an  interest  cost  of  0,  10,  or 

ii  In  this  case  the  shipment  is  an  export  by  a  London  bank,  a 
transaction  which  is  less  common  than  the  N.  Y.  import.  but  nut 
unknown.  The  London  hank  simply  exports  gold  to  a  New  fork 
correspondent  and  immediately  sells  drafts  in  London  upon  that 
correspondent.  The  operation  is  undertaken  upon  the  basis  of  the 
London  price  for  New  York  exchange  and  has  no  reference  whatever 
to  the  New  York  price  for  London  exchange.  However  when  the 
London  rate  on  New  York  is  in  position  for  a  gold  export,  the  New 
York  rate  on  London  will  neees-arilv  be  about  in  position  for  a  gold 
import,  that  is,  the  same  movement. 


538  FOREIGN  EXCHANGE 

20  days.  This,  because  we  do  not  know  the  full  terms  of 
the  bank's  transaction.  The  gold  is,  nevertheless,  locked 
up  just  10  days  in  all  three  cases,  and  there  is  in  all  cases 
a  final  interest  loss  of  just  10  days,  which  would  show  as 
such  if  the  three  calculations  were  reduced  to  final  and 
equivalent  terms.  To  avoid  devoting  too  much  space  to 
this  incidental  though  curious  point  of  theory,  we  will  not 
extend  our  discussion  beyond  giving  an  answer  to  one 
question.  When  a  New  York  bank  exports  gold  and  sells 
demand  sterling,  and  makes  no  interest  charge  against  its 
transaction,  what  has  become  of  the  real  interest  cost  which 
we  nevertheless  know  must  exist  for  the  time  consumed  in 
passage  ?  Suppose  the  bank  is  an  office  of  an  international 
house,  and  makes  the  export  simply  to  the  London  branch 
of  the  same  house.  The  interest  loss  must  be  borne  by 
this  international  house.  The  truth  is,  it  will  fall  upon 
the  New  York  branch.  It  lies  in  the  discount  which  re- 
sides in  the  price  of  demand  exchange  as  compared  with 
cables.  Suppose  a  good  fairy  should  wish  this  particular 
gold  over  to  London  for  the  bank  instanter — or  some  of 
its  spiritualistic  friends  should  "levitate"  it  over — thus 
saving  the  time  required  for  ordinary  passage.  In  what 
form  would  the  consequent  saving  of  interest  to  the  bank 
appear?  The  answer  is,  in  the  shape  of  the  excess  pro- 
ceeds which  it  could  now  obtain  by  selling  cables  instead 
of  sight  drafts.  The  good  fairy  might  enable  it  to  sell 
say  £205,458  (see  Example  2)  of  cables  at  perhaps  4.8850 
instead  of  the  same  sum  of  demand  exchange  at  4.8790. 
Thus  it  would  make  an  extra  gain  of  $1,232.75  which  in 
fact  it  fails  to  get  because  it  really  takes  as  much  time 
for  the  gold  to  get  across  the  sea  as  for  demand  drafts. 
This  sum  is  the  hidden  interest  lost.  Doubtless  this  sub- 
ject should  be  further  explained  to  be  wholly  clear,  but 
we  cannot  afford  to  develop  it  at  greater  length.  The 
calculations  of  interest  costs  as  given  in  the  examples  in 


SPECIE  SHIPMENTS  539 

the  text  are  the  correct  ones  to  show  the  no-profit  gold 
points  in  the  particular  rates  of  exchange  with  which  each 
example  is  concerned.  In  no  case  is  the  time  spent  by 
the  gold  in  transit  to  be  taken  in  and  of  itself  as  the  basis 
for  the  interest  charge  to  be  made  against  a  gold  ship- 
ment in  calculating  the  gold  point  in  any  given  exchange 
rate.  It  is  true  this  time  has  much  to  do  with  the  period 
which  must  elapse  between  the  actual  outlay  and  actual 
return  to  the  shipper,  but  the  latter  period  alone  governs 
the  interest  charge. 

§  141.  Variant  methods  of  calculating  the  interest  charge. 
— By  condensing  Example  6  as  given  on  pages  531-2,  we 
obtain  the  following: 

Initial  outlay  in  London  for  gold  bars  containing 

48,400  ounces  of  fine  gold  £205,480. 

Incidental  expenses  paid  in  London 497.12 

£205,977. 

Net  proceeds  from  bars  on  arrival  in  N.  Y $1,000,410. 

20  days'  interest  deducted,  @  4% 2,218. 

$    998,191'. 

No-profit  purchase  price  for  sight  drafts $4.8461 

(998,192 -=-205,977) 

This  table  exhibits  the  method  which  we  have  employed 
thus  far  in  calculating  the  interest  charge  in  gold  import. 
It  shows  that  (the  price  of  gold  and  the  costs  for  packing, 
cartage,  freight  and  insurance  being  given)  demand  bills 
to  the  amount  of  £205,977,  purchased  in  New  York  for  tin- 
purpose  of  importing  gold,  will  produce  proceeds  from 
the  metal  on  arrival  of  just  $1,000,410.  But  these  returns 
are  received  at  home  20  days  after  the  investmenl  of  home 

12  it  is  assumed  that  the  incidental  expenses  of  £497  are  payable 
in  advance  of  the  shipment,  bo  that  the  operation  is  chargeable  with 
interest  upon  them  aa  well  as  upon  the  "initial  outlay." 


540  FOREIGN  EXCHANGE 

money  in  the  £205,977  of  exchange.  The  sum  of  $1,000,- 
410  receivable  in  20  days,  with  interest  calculated  at  4%, 
has  a  present  worth  of  $998,192,  the  interest  itself  coming 
to  $2,218.  Thus,  if  4%  is  the  market  rate  of  interest  for 
funds  employed  at  home  in  ways  involving  about  the  same 
degree  of  risk  as  an  investment  in  the  operation  of  gold 
import,  the  banker  who  ventures  $998,192  in  the  latter 
business  for  a  return  of  $1,000,410,  makes  just  market  in- 
terest. That  is,  he  makes  no  profit,  in  that  narrow  and 
proper  sense  of  the  term  which  excludes  interest.  If  then 
the  banker  is  to  pay  just  $998,192  for  £205,977  of  ex- 
change, the  rate  of  exchange  will  have  to  be  998,192-=- 
205,977,  or  4.8461.  This  figure  is  therefore  the  no-profit 
gold-import  point  in  the  sight  rate.  If  the  operator  were 
to  pay  more  than  this  figure  per  pound  sterling  for  the 
bills,  he  would  fail  to  make  full  market  interest  in  his 
venture.  If,  however,  he  could  buy  bills  for  less,  he  would 
make  something  more  than  interest. 

A  variant  method  of  reaching  the  same  result  is  shown 
as  follows: 

Total  sterling  outlay £205,977. 

Net  proceeds  from  gold  on  arrival $1,000,410. 

Dollars  of  proceeds  per  pound  of  outlay 

(1,000,410  -^  205,977)    $4.8569 

20  days'  interest  @  4%,  deducted  from  4.8569. . .  .0108 

No-profit  gold  import  point $4.8461 

To  explain :  the  third  item  of  the  table  shows  that  for  each 
£1  of  exchange  purchased,  the  banker  receives  a  return 
of  $4.8569  worth  of  gold  laid  down  in  New  York.  Now 
$4.8461  is  the  sum  of  money  which,  if  put  out  at  4% 
interest  for  twenty  days,  will  earn  $.0108  and  will  amount 
to  $4.8569  at  the  end  of  the  20  days.  It  follows  if  the 
banker  pays  $4.8461  for  £1  of  exchange  which  through  the 
importation  of  gold  converts  into  $4.8569  of  home  mone«y 


SPECIE  SHIPMENTS  541 

at  the  end  of  20  days,  he  makes  just  4%  in  his  venture, 
and  consequently  makes  neither  profit  nor  loss. 

In  the  third  place,  the  calculation  may  take  the  following 
form: 

Initial  outlay  for  gold  in  London £205,480. 

Incidental  shipping  expenses  (see  Example  6) . .  497. 

£205,977. 
Interest  on  £205,977  for  20  days  @  4% 

(calculated  in  sterling) 457.9 

"Total  costs"   £206,434.9 

Receipts  from  gold  in  New  York $1,000,410. 

Receipts  per  £,  or  no-profit  gold  point 

(1,000,410 -T- 206,434.9)     $4.8461 

This  calculation  will  always  give  a  correct  result,  not 
however  because  it  gives  a  correct  representation  of  the 
actual  stages  in  the  import  transaction.  In  fact  it  is  quite 
misleading  in  at  least  one  point,  and  if  given  alone,  tends 
to  confuse  the  reader.  For  instance  it  would  seem  to  in- 
dicate that  the  banker  actually  invests  £205,977  of  sterling 
for  20  days.  But  this,  of  course,  is  not  precisely  what  he 
does.  Furthermore  it  reckons,  or  ought  to  reckon,  the 
interest  on  the  principal  sum  of  sterling  at  the  New  York 
market  rate  of  interest.  And  this  again  would  seem  con- 
fusing. The  reason  why  the  method  followed  in  this 
calculation  works,  is  simply  that  it  happens  to  be  a  precise 
arithmetical,  though  merely  arithmetical,  equivalent  of  the 
true  method.  We  had  best  consign  the  explanation  of 
this  to  a  footnote.13 

is  20  days'  interest,  taking  a  year  as  3G0  days,  is  2%«o  X  4%,  or 
2%oo  X  *ioo,  or  %oo.  The  rate  of  4.8461  is,  in  the  first  and  third 
calculations  given  just  above,  the  result  of  the  division  of  ;i  Bum  of 
dollars  by  a  sum  of  pounds.  The  divisor  and  dividend  are  indicated 
in  each  instance.     In  the  first  and  correct  calculation,  the  result  of 


542  FOREIGN  EXCHANGE 

§  142.  The  gold  points  and  the  mint  par. — A  mint  par  is 
tlir  figure  which  expresses  the  relative  contents  in  pure 
gold  of  the  monetary  units  of  any  two  gold-standard  coun- 
tries.14 So  long  as  two  given  countries  have  free  and 
gratuitous15  (or  virtually  gratuitous)  coinage  of  gold,  the 
mint  par  between  them  will  serve  as  the  fundamental 
regulator  of  the  "gold  points"  in  the  exchange  rates  of 
either  country  on  the  other.  The  gold  points  will  lie  at 
approximately  equal  distances  to  either  side  of  the  mint 
par,  and  therefore  the  latter  will  serve  as  the  approximate 
center  of  oscillation  of  the  exchange  rates.  If  we  examine 
the  practical  calculations  of  the  costs  and  proceeds  of  gold 
shipments  we  see  that  what  the  mint  par  does  is  to  govern 
the  ratio  between  the  initial  outlay  for  gold  in  the  money 
of  the  one  country  and  the  proceeds  received  for  the  same 
gold  in  the  money  of  the  other  country.  Thus  if  £10,000 
of  English  money  is  spent  for  gold  in  London,  this  same 
gold  when  brought  to  New  York  is  bound  to  yield  very 
close  to  4.8665  times  as  many  American  money  units,  or 
$48,665.  If  sovereigns  were  the  form  of  gold  shipped 
out  of  England,  the  only  factors  which  would  make  the 
ratio  of  pounds  sterling  given  up  to  dollars  obtained  vary 
from  1:4.8665,  would  be  deficiency  in  the  weight  of  the 

making  an  allowance  of  20  days'  interest  is  to  reduce  the  dollar,  or 
dividend  number,  from  1,000,410  to  998,192,  or  to  reduce  it  to  just 
90%02  of  itself.  In  the  third  or  last  calculation,  the  effect  of  the 
interest  allowance  as  erroneously  introduced,  is  simply  to  increase 
the  pound,  or  divisor  number,  from  205,977  to  206,434.9  or  to  in- 
crease it  by  %oo  of  itself,  or  make  it  90%oo  of  itself.  It  is  a  fortu- 
nate circumstance  that  an  increase  of  a  divisor  to  90%oo  of  itself  has 
iust  the  same  effect  as  the  decrease  of  a  dividend  to  90%o2  of  itself, 
otherwise  the  common  practical  method  of  figuring  the  interest  cost 
on  a  gold  import  would  not  yield  a  correct  result.  For  it  does  not 
follow  the  facts  of  the  transaction. 

i*  Taking  these  units  as  defined  by  law:  see  formal  definition  of 
the  mint  par,  §  103. 

is  Free  and  gratuitous  coinage  are  distinct.     See  §   105. 


SPECIE  SHIPMENTS  543 

actual  sovereigns  and  the  very  small  charges  of  the  U. 
S.  mint  exacted  in  the  purchase  of  sovereigns.  If  bar 
gold  is  the  form  of  metal  shipped  from  England,  the  mar- 
ket price  per  ounce  payable  in  sovereigns  must  be  to  the 
price  per  ounce  received  in  dollars  very  nearly  as  1 :4.8665. 
This  is  true  because  these  two  prices  must,  as  we  know, 
lie  very  close  to  the  mint  prices  for  gold  in  the  respective 
countries,  and  except  for  the  very  small  coinage  or  stand- 
ardizing charges  made  by  mints,  the  mint  prices  for  fine 
gold  are  one  to  the  other  exactly  in  the  ratio  of  the  mint 
par.  / 

Thus  it  takes  4.8665  dollars  to  contain  as  much  pure 
gold  as  one  sovereign,  and  therefore  of  course,  under  the 
system  of  free  and  gratuitous  coinage  (ignoring  small 
charges  for  standardizing)  the  United  States  mints  are 
bound  to  give  4.8665  times  as  many  dollars  for  an  ounce 
of  pure  gold  as  the  British  mint  gives  sovereigns  for  an 
ounce  of  pure  gold.16  We  know  that  the  total  of  the  in- 
cidental expenses  and  interest  costs  of  a  gold  shipment 
(between  places  as  distant  as  New  York  from  London) 
varies  from  something  less  than  Vi  to  something  less  than 
%  of  1%  of  the  value  of  the  shipment.  If  there  were 
no  incidental  costs  at  all,  the  ratio  between  outlay  for  gold 
in  one  money  (as  pounds  sterling)  and  proceeds  for  the 
same  gold  in  the  other  money  (as  dollars) — namely  the 
ratio  governed  by  the  mint  par — would  be  the  sole  factor 
governing  the  gold  points.  Considering  how  small  the  in- 
cidental costs  are,  this  ratio  remains  1  lie  one  great  influence 

is  The  British  mint  price  for  standard  gold,  ''^ths  line,  is  £3  17s. 
10M;d.,  or  £3.89375,  per  ounce.  The  U.  8.  mint  price  for  gold  Vint  lis 
fine  is  $18.60405  per  ounce.  1:4.8005  is  not  the  ratio  between  these 
two  mint  prices,  but  the  ratio  between  the  mint  prices  for  fine  gold 
deducible  from  them.  The  "basis"  price  (see  §  H>!>)  for  line  gold  i« 
in  England  tilths  times  £3.89376  or  £4.24772.  'Hie  U.  8.  baBic  mint 
price  for  fine  gold  is  $20.67183  (that  is,  "%ths  times  $18.60465). 
Now  4.24772  is  to  20.6718.'}  as  I   is  to  4.8665. 


544  FOREIGN  EXCHANGE 

determining  the  gold-points  and  thus  the  limits  which  con- 
fine  the  fluctuations  of  exchange  rates. 

Roughly  speaking,  the  gold-export  point  is  the  mint  par 
plus  incidental  costs  of  export,  and  the  gold-import  point 
is  the  same  figure  minus  the  incidental  costs  of  import. 
But  a  striking  fact  in  this  connection  is  that,  in  the  case 
of  exchange  between  somewhat  distant  places,  the  under, 
or  import,  point  in  the  sight  rate  of  exchange  is  further 
away  from  the  mint  par  than  the  upper  or  export  point. 
The  reason  is  that  in  gold  import  interest  is  lost  for  a 
period  of  at  least  double  the  time  required  for  the  mail 
and  express  transit  between  the  places;  while  in  gold  ex- 
port there  is  either  no  interest  loss  or  else  a  very  slight 
one. 

If  one  or  both  of  two  given  countries  were  to  suspend 
the  free  coinage  of  gold,  or  were  to  continue  its  coinage 
at  a  substantial  seigniorage,  the  mint  par  would  cease 
to  bear  its  ordinary  relation  to  their  mutual  exchange 
rates.  For  the  imposition  of  a  seigniorage  would  affect 
the  mint  price,  and  consequently  the  market  price  of  gold, 
and  so  would  affect  the  relation  of  outlay  to  proceeds  in 
gold  shipments.  Even  the  slight  seigniorage  of  about  Va 
of  1%  charged  by  the  mint  of  France,  exercises  a  certain 
effect  upon  the  relation  of  the  French  mint  pars  to  the 
gold  points  of  the  exchanges  in  and  on  France. 

§  143.  Special  banking  methods  of  influencing  the  gold 
movement. — Speaking  with  especial  reference  to  countries 
having  the  gold  standard,  it  may  be  said  exportation  of 
gold  has  a  tendency  to  raise  money  rates  and  lower  the 
prices  of  securities,  and  if  long  continued  also  to  lower 
the  prices  of  commodities.  Importation  of  gold  has  a 
tendency  to  produce  the  opposite  results.  It  is  for  these 
reasons  that  the  trading  and  enterprising  classes,  who  are 
usually  interested  in  an  immediate  future  of  lower  money 
rates  and  high  prices,  are  prone  to  regard  gold  import 


SPECIE  SHIPMENTS  545 

as  a  favorable  and  gold  export  as  an  unfavorable  event. 
Since  the  beginnings  of  writing  and  speaking  on  the  sub- 
ject, there  have  always  been  those  to  maintain,  whether 
expressly  or  by  implication,  that  the  national  object  in 
engaging  in  foreign  trade  is,  or  ought  to  be,  to  get  gold 
or  specie  away  from  other  countries.  This  delusion  which 
has  been  repeatedly  exposed  in  the  most  workmanlike 
manner,  seems  fated  to  persist  as  something  impervious  to 
reason.  Akin  to  it  is  the  notion  that  unless  something  is 
done  to  prevent  foreigners  selling  us  their  wares  too  freely, 
we  are  likelj*  to  have  to  export  so  much  gold  as  to  under- 
mine or  destroy  our  gold-standard.  The  reason  why  it  is 
not  absolutely  essential  to  do  something  about  this  is  that 
there  is  a  natural  and  automatic  remedy  for  excessive  ex- 
ports of  specie.  To  call  this  remedy  "natural"  does  not 
signify  that  it  is  necessarily  wholly  good  and  absolutely  all- 
sufficient,  but  merely  that  it  becomes  operative  without 
calculated  action  to  affect  the  specie  movement  being  taken 
by  a  government  or  by  a  great  central  bank.  It  works 
by  changing  the  course  of  trade  or  business,  and  so  depends 
on  human  motivation,  but  it  is  automatic  in  the  sense  that 
no  authority  plans  and  executes  it  with  a  purpose  of  mak- 
ing it  effective.  It  consists  in  a  fall  (whether  absolute 
or  relative)  of  the  prices  of  commodities  within  the  coun- 
try suffering  the  excessive  exports  of  gold.  This  natural 
fall  of  prices  will  be  preceded  by  a  rise  of  money  rates, 
but  it  is  the  fall  of  the  prices  of  goods  that  is  the  funda- 
mental remedy.  The  fall  of  prices  (or  relative  fall  of 
prices  17)  operates  to  check  imports  and  increase  exports  of 
goods  and  thus  to  reverse  the  flow  of  specie. 

It  has  not  been  the  practice  of  all  countries  to  rely  ex- 
clusively upon  the  natural  or  automatic  remedy.  In  time 
of  war  the  government  or  central  bank  of  a  country  is  apt 

17  A  rise  of  prices  less  rapid  in  the  one  country  than  abroad  may 
relative  fall. 


be  called  a  relative  fall. 


546  FOREIGN  EXCHANGE 

to  assume  a  more  or  less  complete  control  of  the  gold 
movement.  In  truth  during  the  great  war  just  closed  this 
action  was  taken  in  practically  all  countries,  belligerent 
and  neutral,  which  possessed  any  gold  put  to  monetary 
use.  However  war-times  aside,  it  has  been  the  policy  of 
some  central  banks  to  employ  certain  special  devices  to 
influence  the  gold  flow  in  the  interest  of  local  financial  com- 
fort. It  is  to  these  expedients  our  attention  is  next  to  be 
directed.  Resort  to  them  is  not  founded  on  the  supposi- 
tion that  the  natural  reinecty  will  fail  but  rather  on  the 
notion  that  the  artificial  ones  may  serve  until  the  turn  of 
the  tide,  and  make  the  experience  less  severe. 

The  measures  in  question  fall  into  two  classes  according 
as  an  effect  is  worked  (1)  on  the  rates  of  foreign  exchange, 
or  (2)  on  the  points  in  these  rates  at  which  gold  shipment 
will  take  place.  The  chief  exemplar  of  the  first  class  is 
manipulation  of  the  discount  rate.  The  institution  which 
has,  up  to  the  present  juncture  in  the  world's  financial 
history,  most  successfully  and  most  regularly  employed 
this  remedy  is  the  Bank  of  England,  England  having  been 
the  county  whose  position  has  made  possible  a  very  ef- 
fective use  of  it.  With  the  British  the  proceeding  has 
often  been  known  as  "correcting  the  exchanges,"  because 
it  acts  to  bring  the  exchange  rates  to  a  more  favorable 
position. 

§  144.  Manipulation  of  the  discount  rate. — As  indicated 
on  earlier  pages,  the  official  discount  rate  of  the  Bank  of 
England  is  ordinarily  non-operative  or  non-effective. 
When  this  is  the  condition  it  stands  above  the  market  rate 
— that  is,  above  the  particular  market  rate  which  applies 
to  the  same  class  of  bills  as  the  bank  rate — and  no  actual 
discounting  goes  on  at  the  bank  rate.  If  now  it  chances 
that  the  demand  for  accommodation  increases  so  as  to  drive 
the  rate  in  the  market  up  to  or  above  the  Bank  rate,  the 
latter  becomes  operative  or  effective  in  the  sense  that  dis- 


SPECIE  SHIPMENTS  547 

counting  begins  to  take  place  under  it.  When  this  hap- 
pens the  Bank's  reserved  discounting  power  is  brought  to 
the  aid  of  the  market.  Now  of  course  the  Bank  has  in 
these  times  the  power  of  determining,  with  limitations,  the 
point  at  which  the  rising  market  will  overtake  the  bank 
rate.  In  other  words  in  times  of  very  active  demand  for 
accommodation  in  the  money  market  the  Bank  may  exert 
a  decided  control  over  market  rates  of  discount.  Some- 
times when  these  rates  do  not  rise  so  high  as  the  Bank 
thinks  they  ought  to  under  the  circumstances  or  in  view 
of  the  position  of  the  exchanges,  it  takes  measures  to  further 
their  ascent.  The  following  is  evidence  on  this  point,  from 
the  interview  granted  the  National  Monetary  Commission 
(U.  S.)  by  the  Bank  of  England.18 

Q.  Does  the  bank  sometimes  borrow  money  in  the  open  market 
for  the  purpose  of  raising  the  market  rate? 
A.  Yes. 

Q.  Do  you  sometimes  sell  consols  for  the  same  purpose  ? 
A.  Yes ;  on  rare  occasions. 

"When  the  bank  sells  consols,  or  British  government  debt, 
with  this  object,  it  is  understood  it  sells  them  for  cash 
and  buys  them  back  "for  the  account"  or  for  future  de- 
livery, the  operation  having  the  effect  of  draining  a  certain 
amount  of  cash  out  of  the  market  temporarily  into  the  bank. 
■Such  proceedings  are  spoken  of  as  "making  the  Bank  Rate 
effective. ' ' 

When  it  is  said  the  Bank  of  England  by  the  agency  of 
its  discount  rate  "corrects  the  exchange"  and  regulates, 
or  at  any  rate,  influences  the  gold  flow  in  and  out  of  Eng- 
land, it  must  be  understood  thai  such  results  as  arc  ac- 
complished follow  only  from  the  effects  which   the   Bank 

is  From  "Interviews  on  Banking  and  Currency  Systems,"  pub 
lished  for  the  National  Monetary  Commission,  1910  (Senate  docU" 
rnent  No.  405,  61st  Congress,  2d  session),  p.  29. 


548  FOREIGN  EXCHANGE 

is  able  to  produce  in  the  open  market  for  money.  For 
it  is  the  open  market  rate,  or  group  of  rates,  that  reacts 
on  the  rates  of  foreign  exchange,  and  not  the  Bank  rate 
in  and  of  itself.  A  rise  in  London  discount  rates  tends 
to  attract  gold  to  London  or  to  restrain  its  outflow.  It 
exerts,  so  to  say,  an  attractive  influence  upon  gold.  If  the 
exchange  rates,  in  some  other  country,  or  countries,  upon 
England  are  almost  in  position  to  cause  a  gold  flow  to 
England,  a  rise  in  the  London  discount  rates  serve  to  pre- 
cipitate or  superinduce  the  movement,  this  being  brought 
about  by  the  tendency  of  the  higher  charge  for  discounting 
to  raise  the  rates  of  exchange  in  the  other  country  or  coun- 
tries. The  elevation  of  the  British  discount  rates  operates 
to  pull  the  exchange  rate  in  the  other  country  up  to  its 
gold-export  point.  If  the  rates  of  exchange  are  moving 
toward  the  point  where  a  gold  outflow  from  England  is 
imminent,  an  elevation  of  the  discount  rates  serves  to  re- 
strain the  movement  by  restraining  the  exchange  rates 
from  falling  to  the  gold-import  point  in  the  other  country. 
When  we  say  an  elevation  of  the  discount  rate  serves  to 
produce  these  effects,  we  should  be  understood  as  meaning 
that  it  tends  to  produce  them,  or  operates  as  one  force  in 
the  direction  of  producing  them.  In  fine,  it  tends  to  bring 
in  gold  or  restrain  its  outflow  according  to  the  circum- 
stances, and  does  so  through  the  effect  it  tends  to  produce 
on  the  exchanges. 

The  information  respecting  the  bank  rate,  contained  in 
"Interviews  on  Banking  and  Currency  Systems,"  cited 
a  moment  ago,  is  of  much  interest  in  this  connection  and 
has  the  advantage  of  possessing  a  semi-official  character. 
From  the  "Report  of  Answers  to  questions  addressed  to  the 
Governor  and  Directors  of  the  Bank  of  England,"  we  take 
the  following  queries  and  replies. 

Q.  How  and  by  whom  is  the  bank  rate  fixed? 

A.  The  bank  rate  is  fixed  at  the  weekly  meeting  of  the  court  of 


SPECIE  SHIPMENTS  549 

directors,  but  the  governor  has  power  to  raise  the  rate  at  any 
intermediate  time,  should  circumstances  in  his  opinion  render 
such  a  course  necessary. 

Q.  When  and  under  what  conditions  is  the  bank  rate  changed? 

A.  The  bank  rate  is  raised  with  the  object  either  of  preventing 
gold  from  leaving  the  country,  or  of  attracting  gold  to  the  coun- 
try, and  lowered  when  it  is  completely  out  of  touch  with  the  mar- 
ket rate  and  circumstances  do  not  render  it  necessary  to  induce 
the  import  of  gold. 

Q.  Do  you  regard  prompt  and  adequate  increase  in  the  bank 
rate  as  the  most  effective  measure  to  protect  the  bank's  reserves? 

A.  Yes. 

Q.  Does  the  raising  of  the  bank  rate  ever  fail  to  attract  gold 
and  change  the  course  of  the  exchanges? 

A.  Experience  seems  to  prove  that  the  raising  of  the  bank  rate 
to  a  sufficient  level  never  fails  to  attract  gold,  provided  the  higher 
rate  is  kept  effective. 

Q.  What  effect  did  raising  the  rate  in  the  period  from  October, 
1907,  to  January,  1908,  have  upon  the  bank's  gold  supply? 

A.  On  the  15th  August,  1907,  the  bank  rate  was  raised  to  4J/£% 
and  so  continued  until  the  31st  October,  when  it  was  further 
raised  to  5%%.  On  the  latter  date  the  total  bullion  held  by  the 
bank  was  £31,700,000  and  the  proportion  of  reserve  to  deposits 
39.9%.  On  the  4th  November,  owing  to  further  withdrawals  of 
gold,  the  governor,  acting  on  his  powers,  raised  the  rate  to  6%. 
On  the  7th  November  the  court  of  directors  raised  the  rate  to  !'.'< , 
the  total  bullion  being  £28,700,000  and  the  proportion  |<>f  the 
reserve]  35.2%.  Thence  forward  the  inflow  of  gold  was  greater 
than  the  outflow,  thus  demonstrating  the  power  of  an  effective  in- 
crease of  rate.19  On  the  11th  December  the  total  bullion  was 
£34,100,000  and  the  proportion  47%.  At  the  end  of  January,  by 
which  time  the  rate  had  been  gradually  reduced  to  4%,  the  total 
bullion  was  £38,500,0(10  and  the  proportion  56.6%. 

i»  An  "effective"  increase  of  rate  here  means  o ffective  in  bring- 

ing  up  the  market  rate  of  discount. 


550  FOREIGN  EXCHANGE 

Q.  From  how  many  countries  did  the  bank  receive  gold  as  a 
result  of  the  increase  at  thai  time? 
A.  Twenty-four,  including  British  colonies.20 

During  November  and  December  of  1907  the  net  ex- 
ports of  gold  to  the  United  States  from  the  United  Kingdom 
were  $85,000,000. 21  It  was  while  London  was  withstanding 
this  drain  that  it  succeeded  in  gathering  in  the  metal  from 
24  different  countries. 

NET  IMPORTS   (U.  S.) 

Nov.,  1907  Dec,  1907 

Total  from  all  countries    $62,959,000  $43,444,000 

From  United  Kingdom   53,311,000  31,244,000 

From  Canada    4,835,000  3,388,000 

From    France    1,414,000  2,900,000 

From  Germany   1,250,000  10,000 

From  Monthly  Summary  of  Commerce  and  Finance   (Department  of 
Commerce  and  Labor)  for  Nov.,  1907,  p.  855,  and  Dec,  p.  1053. 

It  devolves  upon  us  next  to  examine  the  mechanism 
through  which  an  elevation  of  the  discount  rate  works  out 
its  effects  on  the  gold  movement.  In  the  course  of  this 
examination  we  shall  discover  why,  heretofore  at  any  rate, 
England  alone  has  been  in  a  position  to  utilize  this  remedy 
systematically  and  with  striking  success.  It  may  be  said 
in  a  general  way  that  for  London  to  raise  its  money  rates, 
or  charges  for  short-term  advances  of  various  descriptions, 
will  necessarily  tend  to  quicken  repayments  by  foreigners 
of  funds  borrowed  there  and  restrict  the  demands  of  these 
same  people  for  further  accommodation.  Thus  it  tends 
to  augment  the  inward  and  decrease  the  outward  flow  of 
money  funds,22  and  exerts  an  influence  in  the  direction  of 
bringing  in  gold.     But  such  a  statement  does  not  serve  as 

20  From  "Interviews,"  etc.,  as  cited,  pp.  20-7. 

21  Beneath  are  given  some  further  details  of  the  imports  of  gold 
into  the  United  States  during  these  months. 

22  Or  of  "monev"  as  some  would  say. 


SPECIE  SHIPMENTS  551 

an  adequate  explanation.  To  obtain  this  it  will  be  in- 
cumbent on  us  to  enter  into  the  subject  more  technically. 

The  ordinary  gold  movement  depends  on  the  rates  of 
exchange.23  The  very  first  effect  of  an  elevation  of  the 
discount  rate,  is  an  increase  of  the  spread  between  the  sight 
and  long  rates  of  exchange  in  other  cities  upon  the  city 
where  the  discount  rate  is  raised.  Thus  if  discounts  are 
advanced  in  London  the  first  effect  on  the  exchanges  will 
be  an  increase  in  the  spreads  between  sight  and  long  ster- 
ling in  the  various  money  capitals  of  the  world.  If  the 
London  market  discounts  the  60  days'  acceptances  of  Lon- 
don bankers  at  3%,  the  spread  between  the  sight  and  60 
days'  rates24  in  New  York,  would  normally  be  2.90  cents 
per  pound.  But  if  this  rate  rises  to  5%,  the  spread  would 
increase  to  4.25  cents.25  But  the  gold  movement  does  not 
depend  on  this  or  any  other  spread  but  upon  the  position 
of  the  sight  rate  itself.  If  the  sight  rate  is  not  at  one 
of  the  gold  points,  but  lies  between,  resting  for  instance 
at  4.85  or  4.86,  there  can  be  no  ordinary  gold  flows  what- 
ever be  the  spreads  between  it  and  the  60  and  90  days' 
rates.  Thus  if  a  change  of  the  discount  rate  is  by  its  re- 
action on  the  exchanges  to  work  some  influence  upon  the 
gold  flows,  it  will  have  to  do  so  by  way  of  its  effect  on 
the  rate  for  sight  exchange. 

Now  in  fact  an  elevation  of  the  discount  rate  in  London 
puts  a  strong  upward  pull  on  the  sight  sterling  rate  in 

23  it  is  admitted  gold  can  be  moved  when  the  exchanges  do  not 
favor  it,  for  it  is  always  possible  to  move  it  even  at  a  loss.  Con- 
ceivably a  central  bank  might  come  to  a  position  where  import  of 
gold  at  a  loss  would  be  reasonable. 

24  That  is,  between  the  rates  for  bankers'  checks  and  bankers  60 
days  bills  on  London. 

25  If  we  compute  according  to  the  practical  method,  employed 
commonly  before  the  war  began,  the  Bpread  is  the  same  whether 
the  sight  rate  is  high  or  low.  For  illustration  (and  discussion  of 
the  slight  error  involved)   see  §  G4. 


552  FOREIGN  EXCHANGE 

New  York,  or  in  any  other  foreign  money  center:  this  is 
because  it  operates  to  restrict  the  supply  of  and  increase 
the  demand  for  sight  sterling.  To  develop  the  reasons 
let  us  analyze  the  case  of  New  York.  (1)  In  ordinary 
limes  London  is  continually  discounting  a  great  stream 
of  long  sterling  bills  drawn  by  American  exporters,  many 
under  sterling  credits  against  sales  of  goods  all  over  the 
world.26  We  are  already  familiar  with  the  ordinary  pro- 
cedure of  our  banks.  On  taking  these  bills  they  forward 
them  forthwith  to  London  for  discount  and  immediate  ster- 
ling credit  and  against  the  credits  so  created  sell  their 
own  sight  drafts.  The  latter  constitute  a  very  important 
element  indeed  in  the  supply  of  sight  sterling  in  New  York. 
The  supplies  of  sterling  exchange  flowing  from  our  exports 
consist  in  the  first  instance  mostly  of  long  bills  because  in 
the  greater  number  of  cases  the  arrangements  of  exporters 
with  their  importers  permit  only  of  the  drawing  of  such 
bills.  But  the  unceasing  flow  of  long  sterling  converts  into 
sight  sterling  by  the  process  just  remarked.  This  con- 
version depends  however  on  the  prompt  and  continual  dis- 
counting in  London  of  long  bills  drawn  on  that  city. 

Now  then  if  London  raises  sufficiently  the  charges  which 
it  levies  for  this  discounting,  our  banks  will  be  induced 
to  invest  in  the  commercial  long  sterling  coming  daily  to 
their  counters.  The  moment  they  take  this  line  they  post- 
pone its  conversion  into  immediate  London  credit  and  thus 
perforce  postpone  the  offer  on  the  market  of  their  sight 
drafts  which  originate  in  this  conversion.  Thus  while  ordi- 
narily London  not  only  permits  but  practically  encourages, 
the  immediate  conversion,  it  has  the  power  through  raising 
its  discount  rates  to  induce  the  postponement,  and  it  has 

26  We  write  of  the  system  as  it  was  at  the  time  of  the  beginning 
of  the  great  war.  The  present  tense  is  used  on  the  theory  that  when 
financial  conditions  become  settled  we  shall  find  that  the  same  sys- 
tem is  in  good  part  enduring. 


SPECIE  SHIPMENTS  553 

the  power,  through  positively  refusing  to  discount,  to  force 
postponement.  Therefore  it  has  the  power  to  switch  off 
from  our  market,  for  the  time  being,  a  large  element  of 
the  supply  of  sight  sterling  bills.  Meanwhile  the  demand 
for  this  same  exchange  to  cover  maturing  sterling  accept- 
ances created  under  commercial  credits  issued  by  our 
banks  in  the  immediate  past,  and  to  cover  maturing  finance 
bills,  and  to  pay  off  travelers'  checks,  will  continue  for  the 
time  being  unabated.  All  this  operates  to  raise  the  rate  in 
New  York  for  sight  sterling. 

(2)  We  have  already  seen  that  if  the  London  money 
rates  are  enough  under  those  of  New  York  there  is  a  motive 
to  draw  and  sell  bankers'  long  sterling  in  New  York  (com- 
pare Chapter  XII).  These  so-called  "finance  bills"  con- 
vert into  a  supply  of  sight  sterling.  Sight  sterling  to  the 
amount  of  the  proceeds  of  the  discount  of  these  bills  in 
London  is  regularly  drawn  and  sold  in  New  York.  A  suffi- 
cient elevation  of  the  London  discount  rates  will  put  a 
stop  to  the  drawing  of  finance  bills  and  thus  cut  off  from 
our  market  any  element  in  the  supply  of  sight  sterling  that 
flows  from  them.  So  far  as  this  influence  goes,  then,  and 
when  it  is  operative,  it  tends  to  raise  the  rate  for  sight 
sterling  or  to  prevent  its  falling,  this  by  restricting 
supply. 

Finance  bills  falling  due  in  London  are  sometimes  met 
by  the  drawing  and  sale  of  new  ones  on  this  side.  A  rise 
in  the  London  discount  rate  tends  to  check  such  renewals, 
and  thus  once  again  operates  to  raise  or  to  sustain  the  sight 
rate.  AVhen  a  finance  bill  falls  due  and  is  not  renewed 
(replaced  would  be  the  more  accurate  word)  the  company 
drawing  it  will  have  to  go  into  the  market  on  this  side  to 
purchase  sight  bills  for  cover.  But  if  the  renewal  lakes 
place  this  purchase  is  either  avoided  or  flic  clement  of 
demand  which  it  constitutes  is  offset  by  a  new  and  equal 
element  of  supply.    If  the  elevation  of  discounts  in  London 


FOREIGN  EXCHANGE 

prevents  those  renewals  it  has  the  effect  of  precipitating 

these  elements  of  demand  in  our  exchange  market  and  thus 
works  in  the  direction  of  a  high  rate  for  sight  sterling. 
In  fact,  if  London  has  recallahle  funds  placed  out  in  any 
manner  in  the  New  York  money  market,  high  money  rates 
in  London  tend  to  produce  the  return  of  them  to  England, 
and  this  return  will  engender  an  extra  demand  for  sight 
sterling  as  a  means  of  transfer  of  the  funds  home.27 

(3)  If  London  money  rates  are  high  enough,  more  par- 
ticularly if  they  are  higher  fhan  our  own,  they  tend  to 
produce  the  lending  of  funds  in  England  hy  American 
hanking  institutions.  Any  transfer  of  funds  thither  for 
this  purpose  requires  purchases  of  sight  sterling  (or  its 
equivalent)  and  thus  an  added  element  of  demand  for  this 
kind  of  exchange  is  brought  into  heing,  which  tends  to 
raise  or  sustain  the  rate. 

In  sum  then,  for  London  to  elevate  its  discount  rates 
tends  at  the  time  to  restrict  the  supply  of  and  increase 
the  demand  for  sight  sterling  in  our  market.  If  the  rate 
for  this  kind  of  exchange  is  already  high,  standing  let  us 
say  at  4.87,  this  influence  may  be  enough  to  draw  it  up  over 
the  gold  export  point  and  produce  a  flow  of  the  metal  to 
England.  If  the  rate  is  low  and  falling  towards  the  import 
point,  the  influence  may  work  to  prevent  it  reaching  this 
point  and  thus  save  London  from  a  gold  outflow.  If  this 
outflow  would  prove  embarrassing  at  the  moment,  the 
weapon  might  be  used  to  prevent  it. 

It  is  not  possible  to  lay  down  a  very  significant  general 
rule  regarding  the  strength  or  potency  of  the  remedy. 
If  the  commercial  and  financial  forces  or  tendencies  resi- 
dent in  what  we  may  call  the  natural  situation  are  work- 
ing in  the  direction  of  drawing  gold  from  London,  resist- 

st  If  cables  or  long  bills  should  be  bought  as  a  means  of  transfer, 
the  same  effect  upon  the  sight  rates  will  be  worked  indirectly  as  if 
sight  bills  themselves  were  asked  for. 


SPECIE  SHIPMENTS  555 

ance  may  be  put  up  by  the  manipulation  of  the  discount 
rates  of  that  city.  The  effectiveness  of  the  resistance  de- 
pends on  the  strength  of  the  natural  pull  and  there  is  no 
particular  way  open  to  us  to  define  this  quantitatively  or 
to  measure  it.  It  will  be  enough  to  say  that  the  remedy 
is  really  in  practice  a  very  potent  one.  That  it  has  much 
greater  force  when  employed  by  England  than  by  any 
other  country  at  present  depends  sinipty  on  the  fact  that 
it  is  London  alone  which  discounts  long  bills  drawn  upon 
itself  in  vast  quantities  from  all  over  the  world  and  which 
therefore  has  the  power  by  checking  this  accommodation 
to  precipitate  a  demand  for  sight  exchange  upon  itself 
which  may  send  gold  hurrying  to  it.  In  short  London 
is  in  the  position  of  a  money  lender  with  an  immense 
short-term  loan  fund  placed  in  other  countries,  which  is 
in  large  part  virtually  though  not  literally  out  on  call. 
London  is  a  short-term  international  creditor.  It  has  been 
for  years  the  only  exemplar  of  a  city  holding  such  a  posi- 
tion. Cities  not  holding  a  similar  position  cannot  use 
London's  remedy  for  a  gold  drain  with  the  same  effect. 
Take  Berlin  before  the  war.  It  could  not  precipitate  an 
immense  demand  for  sight  marks  in  other  countries  by 
raising  its  discount  rates.  To  save  itself  from  embarrass- 
ment it  (or  more  particularly  the  Eeichsbank)  made  a  prac- 
tice of  holding  a  good  quantity  of  foreign  bills,  that  is 
bills  maturing  in  and  payable  in  money  capitals  foreign 
to  Germany.  By  realizing  upon  these  in  the  cities  where 
they  were  payable  and  using  the  proceeds  to  buy  mark 
exchange,  the  price  of  sight  exchange  on  Germany  could 
be  favorably  influenced  on  occasion.  To  the  extent  to 
which  the  German  bank  held  these  foreign  bills  if  was  a 
creditor  at  short  term  of  other  countries  and  could  use 
its  position  as  such  to  defend  itself  from  a  gold  drain. 
But  Berlin  did  not  have  technically  quite  the  same  weapon 
hs  London  and  its  strength   was  small  as  compared    with 


556  FOREIGN  EXCHANGE 

London's.     London  does  not  operate  by  holding  bills  drawn 
on  ami  payable  in  other  money  capitals. 

The  foregoing  statement  might  prove  misleading  if  we 
should  fail  to  couple  with  it  the  admission  that  other  mone- 
tary capitals  than  London  can  assuredly  exert  a  certain 
degree  of  influence  upon  the  exchanges  by  the  elevation  of 
their  discount  rates.  The  weapon  is  probably  more  effec- 
tive, under  their  circumstances,  for  defensive  than  for  of- 
fensive purposes.  They  can  use  it  to  better  advantage  to 
resist  withdrawals  of  gold  than  to  induce  its  inflow.  When 
any  other  city  develops  the  business  of  discounting  foreign- 
drawn  long  bills  to  something  like  the  colossal  proportions 
to  which  London  has  driven  it,  it  will  be  able  to  use  Lon- 
don's remedy  with  something  like  London's  results.  The 
following  answers  for  the  Reichsbank  express  the  opinion 
of  leading  German  bankers.28 

Q.  What  steps  do  you  take  to  increase  your  gold  reserve  or  to 
protect  it? 

A.  We  always  have  a  large  amount  of  bills  of  exchange  payable 
in  foreign  countries,  payable  in  gold. 

Q.  What  amount  of  foreign  bills  did  you  have  on  December  31  ? 

A.  It  was  very  small  at  the  end  of  the  year,  but  before  it  was 
much  greater. 

Q.  You  must  have  taken  some  steps  to  add  to  your  gold  at  that 
time.     What  steps  did  you  take? 

A.  We  increased  the  rate  of  discount.  We  consider  that  this 
measure  is  the  only  effective  one. 

Q.  How  high  was  the  rate  at  that  time? 

A.  Seven  and  one-half  per  cent. 

Q.  If  this  increase  had  not  been  sufficient,  you  would  have 
further  increased  the  rate? 

A.  Yes. 

§  145.  Manipulation  of  the  price  of  gold. — It  is  on  occa- 
sion open  to  the  central  bank  of  a  European  country  to 

28  "Interviews,"  etc.,  pp.   356-7. 


SPECIE  SHIPMENTS  557 

make  use  of  that  certain  limited  control  it  has  over  the 
price  of  gold,  to  influence  the  national  gold  movement. 
Except  in  a  country  on  the  limping  gold-standard  (for 
example  France),  this  is  necessarily  a  less  potent  remedy 
than  manipulation  of  the  discount  rate,  and  as  already 
intimated,  contrasts  with  the  latter  in  that  it  affects 
not  the  rates  of  exchange  but  rather  the  gold-points 
in  these  rates.  By  the  price  of  gold  we  mean  of  course 
the  quantity  of  the  money  of  any  given  country  that  can 
be  procured  in  exchange  for  an  ounce  or  other  physical 
unit  of  gold  metal.29  "We  have  alreadj^  seen  that,  even  in 
a  gold-standard  country,  this  price  may  undergo  slight 
variations,  owing  principally  to  the  effects  of  the  two  tech- 
nical factors  (1)  the  charge  for  converting  bullion  into 
coin  and  (2)  tolerance  (whether  for  error  in  minting  or 
for  abrasion  in  circulation). 

Further  explanations  can  be  given  most  conveniently  in 
the  form  of  a  discussion  of  the  management  of  the  price  of 
gold  by  the  Bank  of  England.  It  is  not  only  a  matter 
of  common  knowledge  that  this  institution  does  at  times 
change  its  buying  as  well  as  its  selling  price  for  gold,  but 
we  have  its  semi-official  statement  to  this  effect  in  "Inter- 
views," etc.  (already  cited)  as  follows: 

Q.  What  are  the  provisions  of  law  with  reference  to  the  pur- 
chase of  gold  by  the  bank? 

A.  Under  the  act  of  1844  all  persons  are  entitled  to  demand 
notes  in  exchange  for  bar  gold  at  the  rate  of  £3  17s.  9d.  per  ounce 
standard,  subject  to  such  gold  being  melted  and  assayed  at  the 
expense  of  the  seller  by  persons  approved  by  flic  hank. 

Q.  What  is  the  usual  price  paid  by  the  bank  for  gold  purchases? 

A.   (See  answer  to  previous  question.) 

Q.  Does  the  hank  under  some  conditions  advance  its  rate  Eoi 
gold  purchases? 

20  Such  as  the  £3  17s.  Od.  for  an  ounce  of  ni:j,ns  lin'"  alwayB  pro 
curable  at  the  Bank  of  Entrland  as  a  minimum.  Compare  Chapter 
XVI,  and  also  §   131. 


558  FOREIGN  EXCHANGE 

A.  Yes. 

Q.  Under  what  circumstances  and  to  what  extent  does  the  bank 
charge  a  premium  for  gold  bullion  or  foreign  coin? 

A.  When  there  is  a  demand  for  either  gold  bullion  or  foreign 
coin  for  export  to  another  country  the  bank  follows  the  same 
rule  as  t he  seller  of  any  ordinary  commodity. 

The  German  Reiehsbank  has  also  made  it  a  practice. at 
times  to  raise  its  buying  price  for  foreign  coin  as  an  auxil- 
iary measure  to  attract  gold.  The  following  is  from  "Inter- 
views," page  357.  A  vice-president  and  a  director  of  the 
Reiehsbank  are  responsible  for  the  answers  given. 

Q.  Are  there  any  other  steps  taken  to  increase  the  import  [of 
gold]  ? 

A.  Well,  besides  granting  loans  without  interest  on  gold  im- 
ports, we  may  raise  .  .  .  our  tariff  for  the  purchase  of  foreign 
gold  coins,  as  the  Bank  of  England  does. 

Q.  Pay  a  higher  price? 

A.  Yes;  but  this  is  not  important.  The  real  remedy  is  to 
raise  the  rate  of  discount,  besides  selling  a  certain  amount  of 
foreign  bills.30 

The  Bank  of  France  has  customarily  placed  a  greater 
reliance  in  raising  the  price  of  gold  than  any  other  central 
bank.     Section  146  will  deal  in  particular  with  this  subject. 

Let  us  now  suppose  that  the  Bank  of  England  wishes  to 
restrain  an  actual  or  an  impending  outflow  of  gold  to  New 
York,  by  the  method  of  raising  its  asking  price  for  gold 
bars  or  American  or  other  foreign  gold  coin  which  it  may 
hold.  Disregarding  the  defense  it  ma}r  make  by  means  of 
its  discount  rate,  we  are  to  consider  the  nature  and  limita- 
tions of  this  distinct  and  secondary  remedy.  In  the  first 
place  when  England's  gold  standard  is  truly  operative  and 
when  banking  conditions  are  normal,  any  one  having  a  valid 
check  on  or  a  deposit  in  a  bank  may  procure  therefor 

so  The  foreign  bills  referred  to  are  those  payable  and  discountable 
in  foreign  gold  standard  countries,  in  which  the  Reiehsbank  made 
it  a  policy  to  keep  a  revolving  fund  invested.     Cf.  p.  556  above. 


SPECIE  SHIPMENTS  559 

British  legal  tender.  For  any  sizable  amount  this  will 
have  to  be  Bank  of  England  Notes  or  British  gold  coin 
(to  which  we  must  add  since  the  war  began,  the  National 
Currency  Notes  which  are  redeemable  in  gold  coin).  The 
Bank  of  England  notes  as  well  being  redeemable  in  gold 
coin,  it  is  under  normal  conditions  possible  to  convert 
"money"  in  hand  or  in  a  bank  into  gold,  at  the  rate  of 
one  sovereign  (the  one  pound  coin)  to  the  pound  sterling 
of  "money"  of  any  other  kind. 

In  practice  the  maximum  cost  of  gold  obtained  in  this 
manner  will  be  something  in  the  neighborhood  of  £3  18s. 
0%d.  per  ounce  %  fine,  and  the  mini  mum  cost  will  be 
about  £3.  17s.  10/£d.  If  the  sovereigns  procured  averaged 
the  exact  weight  and  fineness  provided  by  law  for  a  new 
sovereign,  the  cost  would 'necessarily  be  £3  17s.  I01/£d.  and 
no  more:  this  for  reasons  already  explained  (cf.  page 
496).  But  because  of  the  tolerance  by  law,  as  a  prac- 
tical necessity,  of  small  deficiencies  in  the  gold  contents  of 
sovereigns,  whether  caused  by  error  in  minting  or  by  abra- 
sion in  circulation,  it  is  possible  that  the  coin  actually  ob- 
tained may  be  on  the  average  .2  or  .3  of  1%  short  in  weight, 
so  that  the  cost  of  the  metal  they  contain  would  amount 
to  about  £3  18s.  0%d.  of  currency.31  When  any  one  de- 
mands sovereigns  from  the  Bank  of  England,  that  institu- 
tion owes  him  the  duty  of  paying  in  coin  that  retain  its 
legal  tender  power.  It  can  readily  discharge  this  duty  by 
delivering  sovereigns  on  the  average  say  %  of  1%  short 
in  weight.  The  person  in  question  would  probably  not 
fare  enough  better  by  collecting  sovereigns  from  the  gen- 

31  A  sovereign  may  weigh  so  little  as  1 J ii . .">  grains  gross  and  retain 
its  full  legal  tender  power.  This,  compared  with  the  statutory  Eull 
weight  of  123.27  +  grains  gross,  Bhows  a  shortage  of  more  than 
.6  of   1%.     The  British   mint    (acting   on    the   rule    followed    bj    all 

mints)  exchanges  new  sovereigns  for  bullion  at  a  rate  Bel  on  the 
theory  that  the  sovereigns  are  exactly  of  full  weight,  thus  at  tho 
rate  of  £3  17s.  10^  d.  per  ounce  '  > [^the  line.    Compare  §  131. 


560  FOKKKJN    KX CHANGE 

era]  circulation  to  pay  for  the  trouble,  to  say  nothing  of 
the  difficulty  in  getting  together  in  this  manner  enough 
gold  for  a  shipment. 

Gold  bars  may  usually  be  had  in  the  London  market  for 
less  than  £3  18s.  0!kl.,  being  in  fact  often  procurable  at 
£3  17s.  9d.,  the  Bank's  minimum  buying  price,  but  the 
fact  that  England  is  on  the  gold  standard32  is  of  itself 
not  a  guaranty  that  they  can  be  obtained  cheaper  than 
£3  18s.  plus.  Thus  at  times,  when  the  market  is  not  well 
supplied  with  bars,  the  Bank  may  easily  force  the  intend- 
ing exporter  of  the  metal  to  pay  this  higher  figure. 

The  gold  reserve  held  by  the  issue  department  of  the 
Bank  of  England  to  redeem  its  notes  consists  not  only  in 
legal  tender  sovereigns  but  also  in  large  quantities  of  bars 
and  foreign  coin.  If  necessary,  the  latter  could  be  taken 
to  the  mint  for  conversion  into  sovereigns,  but  often  an 
exporter  of  gold  who  presents  notes  for  redemption  will 
be  glad  to  take  bars  or  foreign  coin,  especially  coin  of 
the  country  to  which  he  proposes  to  make  a  shipment.  This 
gold  is  not  legal  tender  money  of  England.  Its  delivery  to 
the  person  offering  notes  is  not  strictly  speaking  redemption 
of  these  notes  but  is  really  a  sale  of  a  commodity  for  them. 
Legally  the  price  of  this  commodity  is  purely  a  matter  of 
bargain  between  the  bank  and  this  person,  though  of  course 
if  the  latter  accepts  the  bank's  figure  and  surrenders  the 
notes,  these  instruments  may  then  be  treated  as  redeemed 
and  may  be  cancelled.  What  we  have  been  concerned  to 
show  is  that  there  is  an  economic  rather  than  a  legal  upper 
limit  upon  the  bank's  asking  price.  This  is  the  £3  18s. 
O^d.  just  mentioned.  If  the  bank  demands  more  than 
this  per  ounce  of  bars  11/i2  fine,  the  note  holder  will  imme- 
diately exercise  his  option  to  demand  legal  tender  sovereigns 
by  way  of  a  genuine  and  technical  redemption,  and  so 
secure  gold  at  about  this  cost. 

32  Speaking  as  if  the  return  to  pre-war  conditions  were  assured. 


SPECIE  SHIPMENTS  561 

Assume  that  the  rate  for  sterling  exchange  has  fallen 
in  New  York  to  the  ordinary  gold-import  point,  and  that 
London  agents  of  American  bankers  are  making  inquiry  at 
the  Bank  of  England.  This  institution  may  now,  if  it 
chooses,  exercise  its  right  to  demand  better  than  the  mint 
price  for  the  purpose  of  restraining  or  delaying  the  export, 
and  perhaps  bars  cannot  be  had  in  the  market  any  cheaper 
than  from  it.  If  the  influences  depressing  sterling  in  New 
York  are  strong  enough,  the  rate  may  continue  on  down- 
ward until  the  obstruction  set  up  by  the  Bank  is  overcome. 
For  this  obstruction  consists  merely  in  the  establishment 
at  New  York  of  a  lower  gold-import  point  than  the  ordi- 
nary one.  Should  the  rate  of  exchange  actually  descend 
to  this  lower  point  shipments  at  a  profit  become  as  feasible 
as  ever.  This  is  only  to  say  that  the  higher  the  cost  of 
gold  metal  in  London  in  exchange  for  British  currency, 
the  lower  must  be  the  price  (in  U.  S.  money)  at  which 
the  shipper  can  buy  a  pound  of  sterling  sight  draft  in 
New  York  in  order  to  engineer  the  transfer  of  gold  at  a 
profit. 

To  illustrate,  suppose  a  New  York  bank  arranged  for  a 
.shipment  from  London  of  bars  with  a  content  of  50,000 
ounces  of  British  standard  gold.  The  bars  may  actually 
be  ''mint  fine,"  that  is  perhaps  .9995  fine.  If  so  they  will 
not  weigh  50,000  ounces  but  the  pure  gold  in  them  will 
be  enough  to  make  that  weight  of  bullion  n/i2  fine.  Assum- 
ing incidental  costs  at  rates  prevailing  some  time  before 
the  war,  the  following  account  of  the  operation  may  be 
made  up.33 

Price  Paid  in  London 
Per  Ounce  n/i2ths  Fine 
£3  17s.  9d.  £3  18s.  0%d. 

Cost  of  gold  in  London  £194,275 £195,104% 

(50,000  X  the  price) 

33  For  explanation  of  the  principles  of  this  computation  sec  §   139. 


562  FOREIGN  EXCHANGE 

Price  Paid  in  London 
Per  Ounce  11/i2ths  Fine 
Incidentals  paid  in  London :         £3  17s.  9d.  £3  18s.  OV&d. 

Packing  and  cartage   10 10. 

Freight  (%'e  of  1%  of  value) .  364 365. 

Insurance  (%o  of  1%  of  value)  97 97. 


Total  Sterling  Outlay  £194,846 £195,576. 

Proceeds  in  New  York: 

45,833%  ounces  fine  gold  sold 

to  Assay  office  @  $20.671834947,458.87 $947,458.87 

Less  charge  for  copper  34   41.40 41.40 


Net  worth  on  arrival  in  N.  Y.. $947,417.47 $947,417.47 

Present  worth  of  same  say  20 

days   prior,   interest   at   say 

4%    945,317.00 945,317.00 

No-profit  gold  import  point  in 

sight  rate. 

(1)  945,317-^194,846    4.8516 

(2)  945,317-^195,576    4.8335 

Summary : 

N.    Y.    gold-import   point   at   extreme   low    price    of 

gold  in  London   4.8515 

Same,  at  extreme  high  price 4.8335 


Difference     0180 

Gold  cannot  always  be  procured  in  London  at  the  legal 
minimum  price.  Again  ti±e  buyer  will  not  often  have  to 
pay  the  maximum.  But  the  foregoing  reckoning  shows 
that  a  rise  in  the  London  quotations  from  extreme  low  to 
extreme  high  will  drive  down  the  American  gold-import 
point  almost  2^  per  pound  sterling. 

Conditions  may  easily  arise  under  which  the  Bank  of 

34  For  method  of  computing  compare  §  130. 


SPECIE  SHIPMENTS  563 

England  would  have  the  power  through  management  of 
the  price  of  gold  to  depress  our  gold-import  point  by  1^ 
or  more.  As  a  remedy  for  a  gold  outflow  such  a  measure 
cannot  be  very  far-reaching,  since  the  influences  which  drive 
the  sight  sterling  rate  in  New  York  down  to  our  higher 
import-point  might  well  continue  to  be  operative  until  the 
lower  point  is  reached  and  gold  actually  pours  in.  But 
the  Bank  of  England  always  has  the  chance  that  these  in- 
fluences will  exhaust  or  partly  exhaust  themselves  mean- 
while. There  is  a  chance  to  postpone  the  gold  flow  and 
even  some  chance  to  prevent  it  altogether.  As  the  rate  for 
sight  bills  on  London  falls  toward  the  lower  point,  4.8315 
(or  4.83,  allowing  15  points  for  profit)  the  demand  for 
this  form  of  exchange  is  likely  to  expand.  This  expansion 
of  demand,  coming  from  various  sources,  might  have  suffi- 
cient force  to  prevent  the  rate's  actually  reaching  4.83. 

So  much  for  management  of  the  price  of  gold  to  restrict 
or  prevent  the  outflow  of  the  metal  from  London.  Similar 
tactics  may  be  employed  to  stimulate  inflow.  By  raising 
its  buying  price  for  bars  or  foreign  coin  the  bank  has  the 
power  to  lower  the  gold-export  point  at  New  York.  If 
sterling  has  approached  the  ordinary  gold-export  point  on 
our  side  but  seems  unable  to  rise  quite  to  it,  the  Bank  of 
England  may,  if  it  desires  especially  to  secure  the  metal, 
contrive  to  bring  the  gold-point  down  to  the  rate  of  ex- 
change. Compare  the  table  of  export-points  presented  on 
page  530.  The  Bank  of  England  appears  never  itself 
to  have  offered  better  than  £3  17s.  I01/£d.  per  British  stand- 
ard ounce,  at  least  prior  to  the  war.35  But  the  price  in 
the  open  market  has  been  known  to  go  2d.  higher  than 
this.30 

35  Cf.  p.  504.  This  is  the  full  mint  price,  and  is  l%d.  above  the 
Bank's   legal  minimum   buying  price. 

as  The  influences  determining  the  upper  and  lower  limits  of  the 
price  of  gold  in  London  were  discussed  in  §§  131  and  132,  as  well  af. 
in  the  present  section. 


564  FOREIGN  EXCHANGE 

§  146.  The  gold-premium  policy  of  the  Bank  of  France. — 
What  has  long  been  known  as  the  "gold-premium  policy 
of  the  Bank  of  France"  is  but  the  policy  of  charging  a 
high  price  for  gold,  under  a  different  name.  There  are, 
however,  certain  special  features  in  the  practice  of  the 
French  central  bank  which  call  for  discussion.  These  arise 
out  of  the  fact  that  France  is  on  the  limping  gold-stand- 
ard (compare  §  124).  Neither  the  United  States  which 
also  remains  on  this  standard,  nor  Germany  which 
was  on  it  until  1907,  have  made  use  of  the  special 
opportunities  which  it  affords  for  charging  a  premium 
for  gold.  There  have  been  times  in  New  York  since  the 
resumption  of  specie  payments  (1878)  when  gold  was 
for  a  brief  period  at  a  premium,  but  these  have  not 
been  cases  where  it  was  at  a  premium  as  compared  with 
silver  coin  or  any  other  forms  of  money  issued  by  or  un- 
der the  authority  of  our  government,  but  cases  where 
all  kinds  of  money  were  equally  at  a  premium  com- 
pared with  bank  credit.  These  were  times  of  temporary 
suspension  of  full  and  free  cash  payments  by  the  banks 
generally. 

Under  the  law  the  Bank  of  France  may  redeem  its  notes 
either  in  French  gold  coin,  or  in  silver  5  franc  pieces,  which 
also  possess  unlimited  legal  tender  power.  There  is  no 
provision  of  French  law  requiring  the  redemption  of  the 
latter  in  gold,  whether  at  government  offices  or  at  the 
Bank  of  France  itself.  It  is,  as  we  have  already  learned, 
the  combination  of  these  two  features  in  a  monetary  sys- 
tem that  gives  rise  to  what  has  been  dubbed  the  "limping 
gold  standard."  When  now  some  operator  in  possession 
of  notes  of  the  Bank  of  France,  the  common  currency  of 
larger  denomination  in  the  country,  presents  them  to  the 
Bank  with  the  purpose  of  procuring  gold  for  export,  this 
institution  may,  if  it  chooses,  exercise  its  lawful  option  to 
redeem  in  5  franc  pieces  of  silver.     If  it  does  so,  it  simply 


SPECIE  SHIPMENTS  565 

refuses  to  let  the  note-holder  have  French  gold  coin  which 
he  might  export  with  or  without  melting  it  into  bars.  So 
far  this  is  evidentty  a  Yery  effective  resistance  to  an  export 
which  would  take  place  at  the  expense  of  the  gold  reserve 
of  the  Bank  of  France.  But  so  far  we  have  not  encountered 
a  premium  on  gold. 

Having  been  refused  gold  coin  of  France  in  redemption, 
our  note-holder  may  attempt  to  bargain  with  the  bank  with 
a  view  to  procuring  gold  bars  or  foreign  coin  in  return 
for  notes,  at  some  figure  above  the  mint  price.  In  other 
words  he  may  offer  a  premium  for  gold,  and  the  Bank  may 
let  him  have  it  at  a  premium.  If  so  it  puts  its  gold- 
premium  policy  into  effect.  From  certain  briefer  expla- 
nations of  this  matter  to  be  found  in  various  texts  on  money, 
it  is  left  open  to  a  reader  to  infer  that  the  Bank  will  pay 
over  French  gold  coin  at  a  premium  when  encashing  its 
notes,  and  thus  redeem  these  instruments  at  a  discount 
in  one  of  the  legal  tender  moneys  of  France.  Such  an 
inference  would  be  a  mistake.  The  Bank  avoids  this  tech- 
nical offense.  The  gold  which  it  offers  to  exchange  at  a 
premium  for  notes,  is  always  bar-gold  or  foreign  coin,  and 
thus  commodity  gold.  Any  person  or  bank  in  any  country 
may  ask  what  he  or  it  please  for  the  gold  commodity. 

Outright  refusal  to  give  up  French  gold  coin  in  redemp- 
tion of  notes  or  payment  of  deposits,  when  the  gold  is 
to  be  exported,  in  itself  constitutes  a  very  effective  remedy 
indeed  against  a  gold  drain.  But  the  Bank  has  not  liked 
to  let  the  matter  rest  at  this  point,  because  to  do  so  would 
put  France  definitively  and  clearly  off  the  gold  standard. 
At  least  this  is  a  fair  inference  as  to  its  state  of  mind. 
Therefore  it  offers  the  gold  commodity  at  a  premium.  This 
premium  has  been  characteristically  slight,  say  from  .4 
to  .8  of  1%.  It  has  served  to  restrain  gold  outflow  while 
hardly  being  equivalent  to  an  abandonmenl  of  the  gold 
standard. 


566  FOREIGN  EXCHANGE 

Ft  is  difficult  to  ascertain  much  respecting  the  extent  to 
which  tlic  Bank  of  France  has  made  use  of  this  measure. 
There  is  a  flotsam  and  jetsam  of  information  on  the  subject 
in  the  literature  which  touches  on  it,  but  little  or  nothing 
official  or  authoritative.  Professor  Arnaune  of  L'Ecole  des 
Sciences  Politiques,  in  his  "La  Monnaie,  Le  Credit  et  Le 
Change"  (Paris,  1909)  gives  a  brief  history  of  the  policy 
of  the  Bank  in  managing  its  discount  rate  and  premium 
on  gold  (pp.  490--494).  He  states  that  this  premium  stood 
as  high  as  .6  of  1%  in  December,  1899  (p.  492)  and  tells 
us  also  that  under  the  second  empire  the  "premium  on 
the  precious  metals"  reached  an  elevation  of  from  1.2  to 
1.5%  (p.  490).  In  a  long  and  careful  article  on  the  sub- 
ject written  in  1901,37  Dr.  R.  Rosendorff  states  that  the 
Bank  of  France  pursues  its  polic3r  in  a  manner  almost 
capricious,  letting  different  applicants  have  gold  at  differ- 
ent premiums.  To  quote:  "It  is  never  easy  to  make  out 
the  objective  of  the  Bank's  policy  at  any  given  time,  and 
the  correspondents  of  German  papers  in  Paris  have  often 
been  at  a  loss  to  report  this  policy  correctly."33  After 
stating  that  the  premium  varies  from  .4  to  .8  of  1%,  he 
goes  on,  "Exact  data  concerning  its  height  cannot  be  se- 
cured, since  the  official  rate  of  premium  is  never  made 
known.  The  items  in  the  newspapers  concerning  it  can  lay 
no  claim  to  credibility."30  The  following  is  an  excerpt 
given  by  Rosendorff  from  a  letter  from  a  French  banker 
made  public  in  a  report  of  the  president  of  the  German 
Imperial  Bank  to  the  Reichstag  (1899):  "When  it  [the 
Bank  of  France]  pays  in  Napoleons  [gold  20  franc  pieces] 

37  In  Conrad's  "Jahrbucher  fur  Xationalokonomie  und  Statistik," 
III  Folge,  21  Band,  pp.  632-GG3.  This  is  an  article  directly  against 
the  position  of  certain  German  publicists  who  recommended  the 
adoption  of  the  French  premium-policy  in  Germany. 

wlbid.,  p.  634. 

39  7  bid.,  p.  635. 


SPECIE  SHIPMENTS  567 

it  never  demands  a  premium  and  could  not  lawfully  do 
so.  In  latter  years  it  has  given  up  Napoleons  in  impor- 
tant sums  only  for  the  payment  for  cotton  in  Egypt.  Here 
again  it  has  not  demanded  a  premium.  .  .  .  The  Bank  sells 
foreign  gold  moneys  and  gold  bars  for  a  premium  over  its 
buying  price,  taking  as  a  basis  the  price  of  fine  gold  at 
London.40  .  .  .  The  Bank  decides  each  day  the  sum  to  be 
released,  and  apportions  it  pro  rata  among  the  bankers 
according  to  their  demands.41 

The  following  from  Hartley  Withers'  "Meaning  of 
Money"  (page  87)  is  an  example  of  an  English  statement 
regarding  the  French  system.  "The  Bank  of  France  does 
not  attempt  to  do  the  business  that  we  regard  as  [interna- 
tional] banking,  which  includes  readiness  to  meet  all  de- 
mands in  gold.  Its  notes  are  convertible,  but  convertible 
at  its  option  into  either  gold  or  silver,  and  it  frequently 
takes  advantage  of  this  option,  when  it  considers  it  undesir- 
able to  part  with  its  gold.  So  that  one  who  has  a  credit 
in  Paris  has  a  credit  of  no  international  value  [sic],  except 
in  so  far  as  he  can  make  use  of  it,  by  means  of  the  ma- 
chinery of  exchange,  to  bujr  a  credit  in  London,  which  is 
convertible  [into  gold]  as  a  matter  of  course."  Much 
along  the  same  line  is  the  declaration  in  Swoboda's  "Die 
Arbitrage"  (p.  423)  that  "the  undependableness  of  the 
bill  on  France  has  as  a  consequence  that  the  Austria-Hun- 
garian Bank  does  not  regard  bills  on  Paris  as  cover  for 
its  notes  although  it  does  so  regard  those  on  London  or 
Berlin." 

In  "Interviews"  etc.,  as  already  cited,  page  216,  we  find 
the  question  and  answer  set  forth  beneath.  The  interview 
was  in  this  case  with  M.  Pallain,  the  governor  of  the  Bank 
of  France  in  office  at  the  time  (1009). 

40  This  means  presumably  that  the  Bank  alters  its  premium  in  ac- 
cordance with  the  variations  in  the  London  price  for  gold, 
4i  P.  03511, 


568  FOREIGN  EXCHANGE 

Q.  Tn  order  to  discourage  the  exportation  of  gold  does  the 
Bank  of  France  sometimes  exercise  the  right  it  possesses  to  re- 
fuse payment  in  gold  and  to  offer  to  pay  its  notes  in  silver? 

A.  The  Bank  of  France  can  not,  of  course,  renounce  its  right 
to  redeem  its  notes  in  gold  or  in  silver,  since  gold  pieces  and 
silver  coins  of  5  francs  are  equally  legal  tender  in  France.  But 
it  only  uses  this  right  with  discretion  and  to  the  extent  that  it 
appears  necessary  in  order  to  prevent  an  unjustitiahle  weakening 
of  its  reserves.  In  no  case,  however,  whatever  may  have  been 
said,  have  we  ever  charged  any  premium  on  French  gold 42  in 
redemption  of  notes. 

This  statement  does  little  to  clear  up  our  uncertainty 
regarding  the  extent  to  which  the  Bank  of  France  follows 
the  plan  of  charging  a  premium  on  gold.  Prior  to 
the  Avar  L'Eeononiists  Francais  published  an  item  entitled 
"premium  on  gold"  in  one  of  its  weekly  summary  tables 
in  its  partie  financiere.  According  to  these  tables  there 
was  but  one  period  of  three  months  during  the  years  1909 
to  1913  inclusive,  when  there  was  any  premium.  These 
were  the  months  of  November  and  December,  1912,  and 
January,  1913,  and  the  maximum  premium  recorded  was 
one  of  .2  of  1%.  But  we  have  already  been  warned  that 
these  published  figures  are  purely  nominal. 

So  far  as  one  can  tell,  European  bankers  and  publicists 
are  agreed  that  some  measures  of  control  of  the  foreign 
gold  movement  are  necessa^  to  a  central  bank,  that  what 
wre  have  here  called  artificial  as  distinguished  from  natural 
remedies  must  be  employed.  The  two  chief  defensive  sys- 
tems are  recognized  as  being  (1)  the  discount  and  (2)  the 
gold  premium  policies.43  The  withholding  of  bar  gold  and 
foreign  gold  coin  from  sale  except  at  a  relatively  high  price 

42  I.e.,  French  legal  tender  gold  coin  as  distinguished  from  gold 
bars  and  foreign  gold  coin. 

<3  See  §  147  for  certain  other  minor  plans  of  influencing  the  gold 
movement. 


SPECIE  SHIPMENTS  5(30 

by  the  Bank  of  England  is  but  a  limited  application  of 
the  gold  premium  policy.  The  Bank  of  England  can  go 
only  to  a  certain  point  in  raising  its  asking  prices  for  these 
forms  of  the  gold  commodity.  If  it  goes  too  far  sovereigns 
will  be  demanded  for  notes  and  it  will  lose  the  gold  any- 
way. But  when  the  outside  public  would  resort  to  the 
similar  alternative  at  the  Bank  of  France  the  latter  presents 
them  with  the  full  legal  tender  silver  coin,  so  that  its  con- 
trol of  gold  withdrawals  will  remain  unimpaired.  The 
one  great  advantage  claimed  for  the  gold-premium  polic}' 
is  that  through  it  the  Bank  of  France  manages  to  defend 
its  gold  stock  without  making  frequent  or  great  changes 
in  its  discount  rate.  There  have  been  times  when  the  Bank 
of  France  has  had  to  raise  its  discount  rate  in  addition  to 
placing  a  premium  on  gold.  The  gold-premium  policy 
cannot  be  regarded  in  the  light  of  history  as  all-sufficient. 
On  the  other  hand  those  who  would  treat  it  as  a  failure  be- 
cause forsooth  the  Bank  of  France  has  sometimes  been 
forced  to  raise  its  rate  of  discount  are  manifesting  an 
extraordinary  prejudice.  In  point  of  fact  the  discount  rate 
of  the  Bank  of  France  has  exhibited  a  stability  unrivaled 
by  that  of  any  other  central  bank  and  has  stood  at  an  av- 
erage below  that  of  the  German  or  the  English  central  bank. 
The  exhaustive  statistical  studies  of  European  bank  rates 
published  by  K.  H.  Inglis  Palgrave  in  his  "Bank  Rate  and 
the  Money  Market"  come  down  to  the  year  1900  inclusive. 
A  table  on  page  196  of  this  book  shows  that  the  total  num- 
ber of  changes  in  the  discount  rate  of  the  central  banks 
were  as  follows: 

1881-1900  1844-1900 

In  England   129     400 

In    Germany    63      116 

In  Belgium   57     173 

In  Holland    45     173 

In  France  21     Ill 


570  FOREKJN   EXCII.WCE 

Nut  only  have  variations  in  the  rate  of  the  Bank  of  France 
been  less  numerous  but  they  have  not  been  so  wide  as  in 
the  ease  of  other  central  banks.44  The  rate  of  the  Bank 
of  France  has  maintained  its  lead  with  respect  to  stability 
on  a  generally  low  level  from  1900  to  the  present  time. 
It  is  not  surprising  that  there  have  been  German  writers 
who  have  wondered  whether  German  industry  and  com- 
merce could  not  secure  benefits  of  the  same  character  by 
having  the  same  system  adopted.45 

It  is  of  course  impossible  to  tell  just  how  much  more 
variable  the  discount  rate  of  the  Bank  of  France  would 
have  had  to  be  if  the  gold-premium  policy  had  never  been 
followed.  It  would  hardly  seem  possible  to  estimate  with 
any  precision  what  its  results  would  be  if  transferred  to 
German}'.  But  it  is  safe  to  state  that  it  would  be  unsuit- 
able for  employment  in  a  country  with  the  position  which 
England  holds  in  international  commerce  and  banking. 
Its  employment  would  in  the  first  place  tend  rapidly  to 
undermine  the  very  position  which  England  has  gained, 
and  secondly  it  would  bej-ond  a  doubt  prove  totally  inade- 
quate to  withstand  such  drains  as  England  is  subjected 
to  while  in  that  position.  Propositions  of  this  character 
are  not  susceptible  of  a  rigid  and  unanswerable  demonstra- 
tion, but  as  a  matter  of  judgment  there  can  be  little  doubt 
of  these   particular   statements. 

While  the  gold-premium  policy  is  doubtless  in  large  part 
responsible  for  the  stability  of  the  discount  rate  in  France, 
and  is  to  be  credited  with  its  share  of  this  benefit,  it  is 
not  without  its  drawback.  When  put  in  force  it  operates 
to  raise  the  gold-export  point  thus  permitting  the  rates  of 
exchange    on    other    gold    countries   to    ascend   to    greater 

•t*  See  numerous  tables  in  Chapters  XIX  and  XX  of  Palgrave's 
work. 

*5  It  was  against  the  notions  of  these  men  that  the  article  by 
Rosendorff,  previously  cited,  was  directed. 


SPECIE  SHIPMENTS  571 

heights  than  they  would  otherwise.  Thus  the  higher  the 
price  in  francs  of  a  check  for  an  English  pound  or  an 
American  dollar,  the  greater  the  cost  in  francs  to  the  French 
of  articles  imported  from  these  countries.  The  premium 
policy  saves  the  French  business  world  from  certain  fluctua- 
tions in  the  discount  rate,  but  whenever  it  is  actually  ef- 
fective, that  is,  actually  operative  to  restrain  gold  export, 
it  results  in  a  greater  depreciation  in  the  purchasing  power 
of  the  franc  over  foreign  moneys,  and  thus  over  foreign 
commodities,  than  would  otherwise  be  experienced.  In 
general  a  premium  of  Wfo,  if  effective  in  the  sense  just 
explained,  would  presumably  add  ^  of  1%  to  the  cost  of 
goods  imported  during  the  time  of  its  sway.  Though  there 
are  French  critics  of  the  policy,  probably  it  is  well  thought 
of  by  the  majority  of  publicists  and  financiers  of  the  coun- 
try. It  would  seem  difficult  to  prove  that  the  losses  which 
it  involves  are  more  important  than  the  gains.  It  would 
be  unsuitable  for  England  (waiving  the  fact  that  it  would 
be  impossible  under  present  English  law)  and  it  would 
be  unwise  for  the  United  States  to  adopt  it — not  that  it 
has  ever  been  proposed  in  this  country.  Some  critics  have 
made  the  point  against  the  French  system  that  while  it 
protects  the  gold  reserve  of  the  central  bank,  it  often  forces 
exporters  of  the  metal  to  gather  it  from  the  general  circu- 
lation (at  a  cost  of  course).  Some  seem  to  think  that  in 
some  fundamental  manner  this  is  very  harmful.  In  the 
judgment  of  the  present  writer  there  is  little  in  this  point. 
§  147.  Further  methods  of  influencing  the  gold  movement. 
— A  measure  which  has  on  occasion  been  employed  by 
European  central  banks  to  expedite  gold  import  is  the  mak- 
ing of  interest-free  advances  against  the  metal  at  the  time 
when  it  is  shipped  from  another  Country.  This  practice 
has  often  been  remarked  by  financial  writers,  but  it  is 
most  satisfactory  to  quote  the  evidence  of  its  existence 
from  the  semi-official  statements  made  in  the  National  Mone- 


672  FOREIGN  EXCHANGE 

fcary  Commissions  Interviews  etc.,  which  has  been  men- 
tioned a  number  of  times  before  in  these  pages.  At  page 
28  of  this  publication,  the  following  occurs. 

Q.  [To  representatives  of  the  Bank  of  England.]  It  is  cus- 
tomary at  such  times  [times  of  crisis]  to  advance  money  without 
interest  to  importers  of  gold  to  cover  the  time  required  in  trans- 
portation .' 

A.  At  such  times  facilities  for  bringing  gold  have  been  given 
in  the  shape  of  free  advances  during  transit,  adequate  security 
having  been  lodged. 

In  the  interview  with  the  governor  of  the  Bank  of  France 
we  find  this  (page  214). 

Q.  "What  measures  are  taken  by  the  Bank  of  France  if  it  wishes 
to  increase  its  stock  of  gold  or  to  stimulate  the  importation  of 
gold? 

A.  The  importation  of  gold  does  not  need  to  be  stimulated  in 
France.  It  takes  place  naturally  under  the  influence  of  the  posi- 
tion of  a  creditor  which  France  always  holds  toward  the  principal 
foreign  markets.  Certain  intermediaries  have  sometimes  asked 
us  to  facilitate  their  operations  of  arbitrage  in  precious  metals 
by  advancing  money  without  interest  for  the  time  required  in 
transportation.  We  have  done  so  several  times  by  crediting  the 
importers  from  the  day  of  shipment,  but  this  operation,  which 
has  its  limits  in  its  own  conditions,  can  not  be  considered  as  a 
premium  for  importation.  Such  premiums,  we  repeat,  would  be 
useless,  in  consideration  of  the  current  importation  which  nor- 
mally overabundantly  supplies  the  French  market. 

In  certain  respects  the  foregoing  seems  a  trifle  disin- 
genuous. The  question  below  was  directed  to  the  repre- 
sentatives of  the  German  Eeichsbank  (see  page  357). 

Q.  Do  you  also  loan  money  without  interest  to  people  who 
are  importing  gold? 

A.  Yes,  that  is  done.  We  make  advances  without  interest  to 
importers  for  the  time  the  gold  is  in  transit;  we  do  that  even  in 
times  when  the  ordinary  gold  import  point  is  not  reached. 


SPECIE  SHIPMENTS  573 

If  the  exchange  rates  are  close  to  the  point  of  bringing 
about  an  inflow  of  gold  into  one  of  these  countries,  it  is 
evident  that  an  interest-free  advance  upon  a  consignment 
of  the  metal  might  well  superinduce  the  movement.  Take 
as  an  illustration  a  shipment  from  New  York  to  Paris. 
The  effect  of  the  advance  is  to  give  the  shipper  his  full 
proceeds  in  Paris  on  the  day  the  gold  leaves  New  York, 
without  interest  cost.  If  the  shipment  is  made  by  a  New 
York  house,  the  latter  might  realize  upon  this  special  benefit 
by  selling  cables  on  Paris  on  the  day  of  export  instead  of 
sight  drafts,  thus  making  the  extra  dollars  that  come  from 
selling  this  higher  priced  form  of  exchange.  Without  the 
advance  this  would  entail  an  overdraft  in  Paris.  If  on  the 
other  hand  the  fund  to  be  produced  in  Paris  is  designed  for 
employment  there,  the  gain  will  take  the  shape  of  an  extra 
week's  interest  upon  the  same.  If  the  shipment  is  engi- 
neered in  Paris  and  is  made  against  a  purchase  of  New 
York  exchange,  the  gain  takes  the  form  simply  of  a 
week's  earlier  return  of  the  francs  laid  out  for  that  ex- 
change. 

The  interest-free  advance  on  gold  shipments  does  not  di- 
rectly affect  the  rate  of  exchange  but  affects  the  point  in  the 
rate  at  which  gold  will  move.  Another  policy — which  may 
in  brief  be  called  "the  foreign  bill  policy" — should  be 
mentioned  in  its  proper  order  at  this  place.  This  is  the 
plan  adopted  by  some  central  banks  of  carrying  among 
their  assets  a  substantial  volume  of  bills  of  exchange  pay- 
able in  and  discountable  in  a  foreign  gold-standard  coun- 
try, or  in  a  number  of  such  countries.  So  fast  as  these 
bills  mature  the  proceeds  which  they  yield  may  be  rein- 
vested in  similar  paper,  and  thus  a  revolving  fund  may  be 
kept  employed,  though  its  quantity  or  value  may  naturally 
be  permitted  to  vary  with  circumstances.  The  interest 
earnings  of  such  a  fund  depend  primarily  upon  the  rates 
of  discount  prevailing  in   the  countries  upon   which  the 


574  FOREIGN  EXCHANGE 

bills  carried  in  it  are  drawn,  and  if  these  earnings  are 
below  those  procurable  in  purchases  of  equally  secure  do- 
mestic paper,  the  fund  is  carried  at  a  greater  or  less  sacri- 
fice. Its  advantage  lies  in  its  availability  as  an  instru- 
ment for  regulating  or  "correcting"  the  exchanges.  The 
fund's  adequacy  as  a  weapon  will  vary  with  its  size.  Not 
to  go  into  historical  or  statistical  detail,  we  may  obtain 
an  illustration  if  (disregarding  the  war)  we  suppose  the 
German  Reichsbank  to  be  carrying  £2,000,000  of  bills  on 
England.  The  rates  of  exchange  between  Germany  and 
England  are  approaching  the  point  where  gold  will  be 
sought  in  Germany  for  export  to  England.  If  the  Reichs- 
bank  desires  to  avert  this,  it  is  possible  it  will  be  able  to  do 
so  by  drawing  on  its  reservoir  of  sterling  bills,  though  this 
depends  on  the  strength  of  the  underlying  influences  which 
work  towards  making  the  exchanges  "unfavorable"  to 
Germany.  The  modus  operandi  is  simple.  The  bank  dis- 
counts in  the  course  of  several  days  enough  of  these  bills 
to  yield  it  a  credit  of  say  £500,000  in  London.  Viewed 
from  the  Berlin  end,  it  is  because  sterling  exchange  is 
getting  too  dear  in  Germany  that  gold  export  threatens. 
The  remedy  may  be  applied  in  Berlin  by  selling  sight 
sterling  there  against  the  London  credit  which  has  just 
been  made  available.  If  these  sales  are  in  sufficient  volume 
they  prevent  the  exchange  rate  from  reaching  the  gold- 
export  point.  Viewed  from  the  London  end,  the  threat 
to  Germany's  gold  stock  comes  from  exchange  on  Berlin 
being  too  cheap.  The  Reichsbank  can  if  it  chooses  operate 
as  well  in  London,  by  using  some  of  the  released  sterling 
credit  to  purchase  bills  on  Berlin  and  sustain  the  rate,  or 
prevent  its  reaching  England's  gold-import  point.  Arbi- 
trage being  possible,  the  two  methods  are  virtually  equiva- 
lent, but  insomuch  as  Berlin  deals  in  exchange  on  London 
much  more  extensively  than  does  London  in  exchange  on 
Berlin,  it  is  more  plausible  to  suppose  the  Reichsbank  to 


SPECIE  SHIPMENTS  575 

operate  by  selling  extra  sterling  in  Germany.  By  draw- 
ing on  its  reserve  of  sterling  bills  it  may  merely  retard 
gold  withdrawals  or  may  avoid  them  altogether.  Subse- 
quently when  exchange  has  righted  itself,  the  bank  may 
begin  buying  long  sterling  again  to  replenish  its  store. 
This  in  and  of  itself  tends  to  produce  gold  export  from 
Germany  but  this  result  is  avoidable  if  the  underlying  con- 
ditions of  the  exchanges  are  favorable  at  the  time  when 
the  replenishment  is  accomplished. 

In  case  it  is  the  exchange  rate  between  Germany  and 
France  that  threatens  a  gold  flow  from  Berlin,  the  Reicks- 
bank's  drawing  upon  its  reservoir  of  sterling  bills  will 
still  serve  as  a  remedy.  It  might  sell  sterling  in  Paris. 
This  would  give  it  surplus  credits  in  that  center  and  enable 
it  to  better  the  exchanges  between  Paris  and  Berlin  either 
(1)  by  purchasing  mark-exchange  in  Paris,  or  (2)  by  sell- 
ing franc-exchange  in  Berlin.  The  Reichsbank  could  get 
its  results  even  by  the  method  of  selling  sterling  in  Berlin. 
This  would  lower  the  value  of  sterling  in  terms  of  marks, 
and  by  reason  of  arbitrage  would  necessarily  work  in  the 
direction  of  lowering  the  value  of  francs  in  terms  of  marks 
as  well.  It  is  to  be  supposed  however  that  the  Bank  would 
not  leave  much  to  arbitrage,  since  it  would  obtain  the  maxi- 
mum for  itself  from  selling  out  its  sterling  in  that  manner 
which  would  forestall  the  arbitrage  operations  by  reason 
of  virtually  including  them.46 

Under  the  conditions  prevailing  before  the  great  war, 
the  institution  placing  the  greatest  reliance  in  the  foreign 
bill  policy  was  the  Austro-Hungarian  Bank.47 

40  For  instance,  if  following  a  sale  of  sterling  in  Berlin  by  the 
Reichsbank  there  should  be  a  buying  of  this  sterling  there  by  an 
arbitrager  and  sale  of  it  by  him  in  Paris,  the  Reichsbank  could  better 
sell  sterling  in  Paris  itself. 

*?  The  Economic  Journal  (English)  for  190!)  contains  an  article  by 
Ludwig  v.  Misea  on  "the  foreign  exchange  policy  of  the  Austro- 
Hungarian  Bank."    Vol.  19,  pp.  201-11. 


576  FOREIGN    EXCHANGE 

It  remains  to  speak  of  what  may  be  called  mere  moral 
.suasion    as   a    check    upon    gold    export.     What    follows   is 
quoted   from    .Mr.    Hartley   Withers'   "Money   Changing" 
beginning  on  page  37). 

*  •  *  the  point  [in  the  rate  of  exchange]  at  which  it  pays  to 
send  gold  to  London  [from  Berlin]  is  theoretically  20  marks  48 
pfennigs.  But  in  November,  1912,  London  ought  to  have  been 
drawing  gold  freely  from  Austria  and  Russia  also,  but  not  a 
shillingsworth  arrived.  The  Statist  of  November  16  made  the 
following  observations : — 

"As  a  matter  of  course,  the  exchanges  continue  to  be  as  un- 
favorable to  Germany,  Austria-Hungary,  and  Russia  as  they  have 
been  for  a  considerable  time  now.  And  equally  as  a  matter  of 
course,  gold  is  not  withdrawn  from  the  State  banks  and  shipped 
abroad.  .  .  .  All  this  shows  what  remarkable  power  the  State 
banks  exercise  each  in  its  own  country.  And  it  shows,  likewise, 
how  very  inadequate  is  the  treatment  of  financial  subjects  by 
economists  in  general.  If  men  always  acted  in  accordance  with 
their  pecuniary  interests  gold  would  be  pouring  out  from  Russia, 
Germany,  and  Austria-Hungary  at  present.  But  the  Govern- 
ments of  the  three  States  have  set  their  faces  against  such  ex- 
ports. The  State  banks  in  each  case  support  the  policy  of  the 
Government,  and  the  subjects  are  all  afraid  to  incur  the  dis- 
pleasure of  the  great  Governments  and  powerful  institutions. 
What  is  still  more  to  the  point,  foreign  bankers  and  merchants 
do  not  dare  to  take  gold  from  any  of  the  three  States.  They, 
likewise,  could  make  a  profit  if  they  knew  how  to  get  gold  out  of 
the  State  banks.  But  either  they  are  incapable  of  inventing  any 
method  that  would  force  the  banks  to  give  the  metal,  or  they  are 
in  too  much  dread  of  the  Governments  to  incur  their  displeas- 
ure." 

Thus  it  appears  that  the  theoretical  doctrine,  which  lays  it 
down  that  the  rates  of  exchange  cannot  move  beyond  the  point 
at  which  it  pays  better  to  ship  gold  than  buy  a  draft,  is  only 
borne  out  where  there  is  a  free  market  in  gold,  and  a  claim  for 
money  carries  with  it  an  unquestionable  right  to  immediate  pay- 
ment in  gold. 


SPECIE  SHIPMENTS  577 

In  "Interviews,"  etc.,  as  before  cited,  the  question  and 
answer  given  below,  appear  on  pages  413  and  414. 

Q.  [To  the  Dresdner  Bank.]  In  times  of  trouble  do  the  large 
banks,  like  your  own,  the  Deutsche  Bank,  and  Diseonto,  co- 
operate with  the  Reichsbank  in  an  endeavor  to  prevent  the  ex- 
portation of  gold? 

A.  Yes.  Opinions  are  divided  as  to  whether  it  is  for  the  good 
of  our  country  to  do  so  or  not.  Last  year,  for  instance,  many 
people  asked  for  gold.  It  was  refused  at  first  in  some  quarters; 
later  we  shipped  freely. 

In  the  same  publication  there  appears  also  the  following 
(at  page  358),  which  is  reproduced  as  a  matter  of  interest: 

Q.  Do  you  take  any  steps  to  prevent  exports  of  gold?  We 
have  been  told  that  it  is  the  habit  of  the  Reichsbank,  in  case  of 
large  exports  of  gold  from  German}7,  to  suggest  to  other  banks 
that  it  is  not  agreeable  to  have  the  gold  exported. 

A.  It  has  never  been  the  ease  and  never  will  be  the  case  that 
such  suggestion  has  been  made  by  the  Reichsbank  to  anybody. 
If  it  happened  during  the  last  crisis  that  some  of  the  banks  re- 
fused to  export  gold,  that  was  done  for  wrongly  understood 
patriotic  reasons.  The  Reichsbank  is  not  in  favor  of  such  meas- 
ures and  it  is  very  sure  that  such  a  thing  will  not  happen  again. 
We  consider  this  measure  absolutely  wrong.  It  was  done  in 
spite  of  the  Reichsbank.  After  it  happened  the  Reichsbank 
approached  the  other  banks,  expressing  the  wish  that  it  should 
not  happen  again. 

It  must  be  conceded  there  are  times  in  practical  life 
when  gold  does  not  flow  out  of  certain  lands  regarded  as 
gold-standard  countries,  even  when  its  export  would  pay 
as  an  exchange  operation.  We  conclude  that  the  theory 
of  the  gold-points  explain  what  happens,  and  why  it  hap- 
pens when  exchange  operations  are  freely  conducted  on 
a  gold  basis.  Usually  gold  tlows  from  leading  gold  coun- 
tries when  the  gold  exporl  points  are  reached.  This  obser- 
vation holds  especially  of  England  and  the  United  States. 


CHAPTER  XXI 

THE  THEORY  OF  EXCHANGE  RATES 

§  148.  Supply  and  demand  and  the  rate. — By  a  "theory" 
of  a  rate  or  value  we  mean  in  economics  merely  a  general 
explanation  of  the  influences  or  factors  which  govern  that 
rate  or  value.  The  law  of  supply  and  demand  will  be  found 
to  play  some  role  in  all  theories  of  economic  values  or  rates, 
but  commonly  other  elements  as  well  are  present,  such  as 
principles  of  utility  and  of  cost.  In  the  case  of  exchange, 
however,  the  explanation  from  supply  and  demand  consti- 
tutes the  whole  theory  of  rates,  for  an  exchange  rate  is 
merely  a  sum  of  money  laid  down  to  buy  a  claim  to  another 
sum  of  money  (payable  it  is  true  as  a  regular  thing  at  an- 
other time  or  in  another  place).  The  demand  for  exchange 
does  not  come  from  any  "subjective"  value  possessed  by 
that  article  explicable,  for  instance,  in  accordance  with 
the  principles  of  marginal  utility,  and  the  supply  of  ex- 
change is  not  checked  or  determined  in  any  way  either  by 
a  subjective  or  an  entrepreneur's  cost  of  production.  The 
theory  of  the  exchange  rate  based  on  supply  and  demand 
is,  however,  not  without  its  complexities. 

The  word  supply  is  to  be  taken  as  meaning  simply  the 
quantity  of  a  thing  offered  for  sale  on  the  market.  When 
the  thing  is  a  material  good,  its  supply  is  measured  in 
physical  units,  as,  for  instance,  bushels  of  wheat.  But 
when  the  thing  is,  instead,  a  claim  to  money,  as  in  the  case 
of  investment  bonds  and  ordinary  negotiable  instruments, 
the  quantity  of  supply  is  measured  in  terms  of  value,  that 
is  to  say,  of  "nominal"  or  "face"  value.  The  nominal 
value  of  any  contractual  claim  for  money  is  the  quantity 

578 


THE  THEORY  OF  EXCHANGE  KATES     579 

of  money  into  which  it  is  convertible  at  maturity  accord- 
ing to  its  terms.  This  nominal  value  is,  of  course,  a  dis- 
tinct thing  from  its  actual  market  price.  A  sixty-day 
bill  of  exchange  (which  is  physically,  by  the  way,  say 
32  square  inches  of  paper),  may  have  a  nominal  value 
of  £1,000,  and  a  market  price  of  $4,830  in  New  York  and 
of  £990  later  on  in  London.  It  constitutes,  however,  a 
supply  of  £1,000  of  sixty-day  exchange.  In  our  discus- 
sion we  shall  take  the  demayid  for  an  article  to  signify  the 
desire  to  obtain  it  existing  on  the  part  of  persons  with  the 
means  to  purchase  it.1 

One  form  in  which  the  principle  of  supply  and  demand 
is  sometimes  stated  is  that,  other  things  remaining  the 
same,  the  greater  the  supply  of  a  thing  offered  upon  the 
market  the  lower  its  price  (and  vice  versa),  and  the  greater 
the  demand  for  a  thing  the  higher  its  price  (and  vice 
versa).  But  the  relations  existing  between  supply  and 
demand  and  price  can  be  stated  in  a  more  definite  formula, 
giving  us  what  is  known  as  the  principle  of  the  "equilib- 
rium of  supply  and  demand."  This  principle  is  that  the 
market  price  of  an  article  seeks  the  point  which  will  make 
the  volume  of  the  article  supplied  and  the  volume  demanded 
come  to  an  equality.  To  illustrate,  suppose  the  rate  for 
bankers'  sight  drafts  in  the  New  York  market  remained 
about  4.85  during  a  day,  and  that  in  the  day  £1,000.000 
of  these  drafts  were  offered  for  sale  and  accepted  by  pur- 
chasers. If  the  price  had  been  4.86  instead  of  4.85,  with- 
out there  being  any  other  changes  in  the  underlying  con- 
ditions of  exchange  supply  and  demand  than  those  caused 
by  this  price  change,  we  know  perfectly  well  the  volume 

i  And  thus  we  do  not  use  the  term  to  designate  the  different, 
though  related  thing,  the  quantity  of  the  article  which  will  be  taken 
o(T  the  market  at  a  given  price  by  the  body  of  purchasers.  The 
latter  is,  however,  the  set  definition  of  "demand"  often  giyen  in 
modern  treatises  on  economics. 


580  FOREIGN   EXCHANGE 

offi  red  on  the  market  would  have  exceeded  the  volume  de- 
manded. Thus,  with  a  rate  of  4.86  perhaps  £1,500,000 
of  drafts  might  be  seeking  sale  while  there  might  be  bids 
for  only  £750,000.  For,  other  things  remaining  the  same 
.  no  other  original  cause  of  change  entering  in),  a  rise 
in  price  calls  out  a  greater  volume  of  supply  (and  vice 
versa),  and  a  rise  of  price  decreases  the  volume  demanded 
(and  vice  versa).-  If  market  price  chances  to  get 
to  a  figure  so  high  that  it  makes  the  volume  of  bills 
seeking  sale  exceed  the  volume  which  is  demanded  at  that 
figure,  the  price  tends  to  fall.  On  the  other  hand,  if  the 
price  happens  to  be  at  a  point  so  low  that  it  makes  the 
requests  for  bills  exceed  the  offers,  the  price  tends  to  rise. 
But  if  the  price  is  at  the  figure  which  just  equalizes  the 
volume  supplied  and  demanded,  it  has  no  tendency  to  move 
one  way  or  the  other  until  a  change  in  underlying  condi- 
tions takes  place.  Thus  we  consider  the  price  which  equal- 
izes bids  and  offers  to  be  in  a  state  of  "equilibrium"  for 
the  time  being.  We  also  speak  of  it  as  just  "clearing" 
the  market. 

To  illustrate  our  meaning  further,  suppose  that  at  a 
time  when  the  market  rate  for  bankers'  demand  drafts  is 
4.85,  the  volumes  of  drafts  which  would  be  supplied  and 
demanded  at  other  rates  (if  these  other  rates  should  hap- 
pen to  be  made),  would  be  as  indicated  below: 


Volume 

Volume 

Supplied 

Price 

Demanded 

£1,300,000 

4.86 

£    825,000 

1,150,000 

4.8550 

900,000 

1,000,000 

4.85 

1,000,000 

900,000 

4.8450 

1,100,000 

800,000 

4.84 

1,250,000 

2  The  volumes  supplied  and  demanded  are,  speaking  with  precision, 
rates  of  inflow  and  offtake  in  the  market;  that  is,  they  are  such  and 
such  quantities  per  day,  per  week,  or  for  some  other  unit  of  time. 


THE  THEORY  OF  EXCHANGE  RATES     581 

We  are  assuming  that  what  actually  happens  on  this  given 
day  is  that  £1,000,000  of  drafts  change  hands  at  a  rate 
of  4.85.  There  would  never  be  a  way  of  knowing  what 
the  volume  of  offers  or  of  inquiries  would  actually  have 
been  on  the  same  day,  under  the  same  underlying  condi- 
tions, if  other  market  rates  had  prevailed.  And  so  the 
figures  given  are  by  very  nature  supposititious.  But  some 
figures  would  necessarily  hold  good  on  a  given  day,  and  the 
point  is  that  the  direction  of  their  changes  would  be  as 
indicated  in  our  table.  That  is,  the  higher  the  rate,  the 
greater  the  volume  of  offers  would  be,  and  the  less  the 
volume  of  inquiries  (and  vice  versa).  The  table  of  the 
volume  that  would  be  supplied  at  each  given  rate  or  price 
is  called  a  "supply  schedule,"  the  table  of  the  volume  that 
would  be  demanded,  a  "demand  schedule."  What  these 
schedules  actually  are  at  any  time,  is  determined  by  what 
we  have  designated  the  "underlying  conditions"  of  supply 
and  demand,  that  is,  primarily  the  conditions  of  interna- 
tional trade  in  merchandise  and  securities  and  the  condi- 
tions of  short  term  international  borrowing  and  lending. 
A  change  of  underlying  conditions  will,  of  course,  shift 
the  supply  and  demand  schedules.  Thus  a  given  change 
might  shift  the  demand  schedule  from  the  position  shown 
above  to  another  one,  as  indicated  beneath: 


Demand  Schedule 

Demand  Schedule 

Under  First  Set 

Under  Second  Set 

Price 

of  Conditions 

of  Conditions 

4.86 

£    825,000 

£1,000,000 

4.8550 

900,000 

1,150,000 

4.85 

1,000,000 

1,300,000 

4.8450 

1,100,000 

1,500,000 

4.84 

1,250,000 

1,750,000 

The  principle  of  supply  and  demand  is  the  affirmation 
that  the  supply  and  demand  schedules  being  what  they  arc, 


C>*2  FOREIGN  EXCHANGE 

the  market  price  lends  to  reach  that  figure  which  will  make 
equal  the  volume  supplied  and  the  volume  demanded,  or 
the  volume  of  the  offers  and  the  bids.  If,  for  instance, 
the  supply  and  demand  schedules  for  bankers'  sight  sterling 
were  to-day  those  first  given  (see  page  580),  then  the  center 
of  oscillation  of  the  market  rate  would  be  4.85,  or  the 
market  rate  would  tend  to  rest  at  4.85.  For  if  it  main- 
tained itself  at  a  higher  figure,  as  at  4.86,  the  offers  would, 
as  indicated  in  the  tables,  come  in  the  course  of  the  day 
to  exceed  the  requests  by  £475,000  of  bills.  There  will 
always  be  some  sellers  who  would  rather  cut  a  price  than 
be  unable  to  make  a  sale,  and  as  long  as  the  price  is  such 
that  there  is  bound  to  be  a  body  of  unsatisfied  sellers,  there 
is  an  insistent  tendency  for  that  price  to  fall.  At  4.84,  on 
the  other  hand,  there  would  be  an  unsatisfied  inquiry  for 
£450,000  of  bills.  So  the  price  would  be  bid  up  from  this 
figure  because  some  buyers  will  always  be  in  a  position 
to  pay  more  rather  than  go  without  the  article  sought. 
But  if  the  actual  market  price  reaches  the  figure  of  4.85, 
namely  the  figure  which  will  at  the  time  make  the  volumes 
supplied  and  demanded  come  to  an  equality,  the  price  then 
neither  tends  to  be  bid  upward  nor  downward.  At  4.85 
the  amounts  supplied  and  demanded  would  both  be  £1,000,- 
000,  and  the  price  would  tend  to  rest  here  until  a  change 
in  underlying  conditions  alters  the  supply  and  demand 
schedules.  In  point  of  fact,  some  change  in  underlying 
conditions,  or  some  change  in  the  speculative  forecast  of 
these  conditions,  is  practically  always  at  work  making 
alterations  in  these  schedules.  Consequently,  the  mar- 
ket price  for  any  given  class  of  bills  is  generally  on  the 
move.  It  is  forever  seeking  and  following  the  moving 
point  which  will  clear  the  market  under  shifting  con- 
ditions. 

§  149.  The  manner  in  which  "supply  and  demand  regu- 
lates" a  rate. — The  explanation  from  supply  and  demand 


THE  THEORY  OF  EXCHANGE  RATES     583 

just  given  has  the  appearance  of  being  circular.  The  gen- 
eral law  is  that  price  depends  on  supply  and  demand,  and 
yet  has  it  not  been  argued  that  the  volume  supplied  and 
demanded  depends  on  price?  There  is,  however,  no  real 
circle  in  the  reasoning.  It  is  true,  both  the  volume  sup- 
plied and  the  volume  demanded  depend  on  price,  but  they 
depend  only  in  part  on  price.  What  the  volume  supplied 
will  be  at  each  single  price  in  the  schedule  or  in  the 
range  of  variation  of  price,  depends  wholly  on  the  inde- 
pendent underlying  conditions  of  the  supply.  And  the 
volume  demanded  at  any  price  within  the  entire  range  de- 
pends wholly  on  the  underlying  conditions  of  demand. 
Thus,  although  price  changes  affect  the  volume  supplied 
and  demanded,  what  the  volume  is  that  they  affect  depends 
wholly  on  underlying  conditions.  Under  one  set  of  condi- 
tions, 4.87  might  make  the  volume  of  the  offers  and  of  the 
requests  equal,  and  under  another,  4.84  might  accomplish 
this  result.  Whether  it  is  4.87  or  4.84  is  determined  by 
the  underlying  conditions  of  supply  and  demand  together, 
and  by  them  alone.  To  summarize :  when  we  say  that 
"supply  and  demand  regulates"  price,  we  mean  that  price 
is  governed  by  the  underlying  conditions  of  supply  and 
demand,  and  in  the  following  manner:  Price  movements 
react  upon  the  volume  of  bids  and  offers,  and  price  neces- 
sarily seeks  the  point  that  will  make  these  two  equal,  or 
the  point  which  will  clear  the  market,  but  what  this  point 
is  depends  wholly  on  the  underlying  conditions  of  supply 
and  demand. 

§  150.  Interpretation  of  apparent  contradictions. — It 
would  take  more  space  than  can  be  devoted  to  this  subject 
to  consider  and  guard  against  all  the  possible  misinterpre- 
tations to  which  the  explanation  just  given  is  open.  It  is 
important,  however,  to  consider  one  or  two  points  in  this 
connection.  Take  such  a  market  phenomenon  as  a  rise  in 
an  exchange  rate  accompanied  by  an  increase  of  the  volume 


584  FOREIGN   EXCHANGE 

of  drillings  on  the  way  up.  Since  sales  and  purchases 
must  always  be  in  exactly  equal  quantities,8  we  have  here 
an  instance  where  there  is  an  expansion  of  the  volume 
of  exchange  demanded  at  the  very  time  when  the  rate  for 
exchange  is  rising.  This  seems  to  contradict  the  law  that 
iht'  volume  demanded  falls  off  as  the  rate  rises.  It  must 
be  kept  in  mind,  however,  that  this  law  holds  only  when 
no  independent  change  takes  place  in  the  underlying  con- 
ditions, and  it  was  stated  with  this  proviso.  Now  in  point 
of  fact  every  consequential  movement  of  the  exchange  rate 
is  due  to  a  change  in  underlying  conditions.  The  striking 
case  of  a  sharp  rise  on  expanded  dealings  is  due  to  such 
a  change  and  is  consistent  with  the  law.  A  sudden  and 
great  increase  in  the  demand  for  exchange,  in  the  sense 
of  the  general  desire  or  need  for  it,  might  be  caused,  for 
example,  by  any  events  tending  to  increase  our  imports 
of  securities  or  merchandise.  Our  importers  as  a  body 
would  come  to  need  more  exchange  than  before  to  settle 
their  indebtedness  abroad.  This  increase  of  demand  would 
mean  that  the  volume  of  bills  which  would  be  asked  for 
in  the  open  market  at  each  and  every  rate  of  exchange 
would  rise  sharply.  It  would  mean  that  a  new  and  higher 
point  of  equalization  of  bids  and  offers,  or  of  clearance  of 
the  market,  would  be  established,  and  that  the  actual  rise 
of  the  rate  is  merely  a  case  of  following  up  its  moving 
"equilibrium"  or  equalization  point  under  a  change  of 
underlying  conditions. 

To  illustrate,  we  may  suppose  a  change  takes  place  in 
the  underlying  conditions  of  the  demand  but  not  of  the 
supply.  Making  use  of  the  supply  and  demand  schedules 
already  given  as  examples  in  §  148,  we  may  construct  the 
following  table : 

a  When  the  stock-market  reporter  speaks  of  ''heavy  selling,"  he 
gives  us,  curiously  enough,  a  half-suggestion  that  sales  may  exceed 
purchases. 


THE  THEOKY  OF  EXCHANGE  RATES 


585 


Volume  Supplied 

Volume  Demanded 

Volume  Demanded 

Under  Both 

Price 

Under  the  First 

Under  the  Second 

Sets  of 

or 

Set  of 

Set  of 

Conditions 

Rate 

Conditions 

Conditions 

£1,300,000 

4.86 

£    825,000 

£1,000,000 

1,150,000 

48550 

900,000 

1,150,000 

1,000,000 

485 

1,000,000 

1,300,000 

900,000 

4.8450 

1,100,000 

1,500,000 

800,000 

4.84 

1,250,000 

1,750,000 

Under  the  first  set  of  conditions  the  market  rate  would 
tend  to  settle  at  4.85,  at  which  point  the  volumes  offered 
and  asked  for  would  be  equal,  namely  £1,000,000  per  day, 
and  actual  transfer  would  take  place  at  the  rate  of  £1,000,- 
000  per  day.  A  change  in  the  conditions  of  demand  inter- 
venes and  the  second  "demand  schedule"  replaces  the  first, 
the  original  "supply  schedule"  being  assumed,  for  sim- 
plicity's sake,  to  remain  unaltered.  Putting  the  second 
demand  schedule  together  with  the  original  supply  sched- 
ule, we  see  that  the  new  equalization  point  in  the  rate  for 
exchange  will  be  4.8550.  At  this  point  offers  and  bids  will 
be  equal,  appearing  in  the  amount  of  £1,150,000  per  day. 
"What  will  happen  then  under  the  conditions  of  this  illus- 
tration will  be  an  ascent  of  the  market  rate  from  4.85  to 
4.8550,  with  an  increase  of  dealings  (an  increase  of  "ac- 
tivity") from  the  amount  of  £1,000,000  per  day  to  that 
of  £1,150,000  per  day.  Under  changed  conditions  the 
volume  demanded  becomes  greater  at  4.8550  (namely 
£1,150,000)  than  it  was  formerly  at  4.85  (namely  £1,000,- 
000).  Meanwhile  it  remains  always  true  that  the  higher 
the  rate  of  exchange,  under  given  conditions  of  the  demand, 
the  less  will  be  the  volume  demanded.  Thus  under  the 
second  conditions  of  the  demand,  a  rate  of  4.86  would  make 
the  volume  demanded  fall  to  £1,000,000  instead  of  £1,150,- 
000,  as  it  would  be  at  the  rate  of  4.8550. 

In  the  foregoing  illustration  we  have  supposed  the  /ate 


686  FOREKJX   EXCHANGE 

of  exchange  to  rise  to  an  accompaniment  of  expanding 
dealings,  appearing  to  refute  the  "law  of  demand,"  but 
in  fact  refuting  a  misconstruction  of  this  law.  On  the 
other  hand,  the  rate  may  fall  to  an  accompaniment  of 
contracting  dealings.  This  shows  the  same  kind  of  ap- 
parent contradiction,  for  it  seems  to  refute  the  principle 
that  the  lower  the  rate  goes  the  greater  will  be  the  volume 
of  exchange  demanded.  The  explanation  here  is  the  same 
in  character  as  before.  This  movement  will  be  due  to  a 
change  in  underlying  conditions,  and  is  not  incompatible 
with  a  principle  which  states  how  the  volume  demanded 
will  behave  when  no  change  originates  in  the  underlying 
conditions  themselves.  If  a  rate  rises  on  expanding  deal- 
ings, it  is  a  sign  that  the  underlying  cause  is  an  increase 
in  the  demand,  in  the  sense  of  the  general  need  for  ex- 
change. If  it  rises  with  contracting  dealings,  the  cause  is 
seme  change  in  underlying  conditions  which  restricts  sup- 
ply, such  as  a  falling  off  of  exports.  The  cause  is  one 
which  operates  to  reduce  the  amount  of  exchange  which 
would  be  offered  on  the  market  at  any  given  price,  and 
which  thus  brings  about  a  decline  of  the  whole  "supply 
schedule.4  It  should  not  be  assumed  that  these  explana- 
tions take  away  the  force  of  the  principles  of  the  equal- 
ization of  bids  and  offers.  It  remains  true  under  station- 
ary, slowly  changing,  or  rapidly  changing  conditions,  that 
too  high  a  price  will  make  offers  exceed  inquiries  (and 
vice  versa)  and  price  actually  seeks  to  reach  the  point 
which  will  lead  to  an  excess  neither  one  way  nor  the  other. 
Speculation  generally  has  the  effect  of  bringing  the  force 

4  When  the  rate  of  exchange  rises  or  falls  in  the  market,  dealings 
may  (1)  expand  or  (2)  contractor  (3)  remain  the  same.  Curiously 
enough,  no  matter  whether  the  volume  of  transactions  behaves  in 
the  first  or  second  or  third  way,  the  "law  of  supply"  or  the  "law 
of  demand,"  or  both,  appear  to  be  refuted!  That  is,  a  misconstruc- 
tion of  them  is  always  refuted  by  any  actual  movement  of  price. 


THE  THEORY  OF  EXCHANGE  RATES     587 

of  anticipated  changes  in  underlying  conditions  to  bear 
upon  the  market  before  they  actually  transpire.  In  all 
cases  of  this  character  the  change  in  rates  receives  its 
ultimate  explanation  in  the  change  of  conditions.  It  is, 
however,  not  to  be  denied  that  speculative  anticipations 
are  often  mistaken.  With  regard  to  rate  changes  caused 
by  mistaken  speculation,  it  would  seem  that  one  can  go 
no  further  than  to  make  the  not  altogether  illuminating 
affirmation  that  they  are  caused  by  mistaken  speculation. 
However,  this  much  may  be  added:  when  the  rate  is  driven 
in  a  given  direction  by  a  supply  of  or  demand  for  bills 
coming  from  mistaken  or  excessive  speculative  operations, 
the  discovery  of  the  mistake  or  excess  when  the  conditions 
of  the  future  actually  materialize,  will  lead  to  operations 
which  tend  to  correct  the  aberration  of  the  rate  first  oc- 
casioned by  the  misguided  speculation.  We  see  these 
things  in  the  liquidation  of  misguided  "longs"  and  the 
covering  of  misguided  "shorts."  Sometimes  the  volume 
of  the  demand  in  a  market  increases  as  price  rises,  be- 
cause as  the  thing  proceeds  the  imitative  speculators  pres- 
ent detect,  or  think  they  detect,  the  evidence  of  "good 
buying"  by  big  men  and  leaders.  If  the  leaders  are,  in 
fact,  buying  because  of  correct  anticipation  of  future  con- 
ditions which  will  work  for  higher  prices,  we  have  in  this 
instance  merely  an  early  concentration  of  the  effects  of 
these  conditions. 

We  may  regard  the  doctrine  that  price  seeks  the  figure 
which  will  equalize  bids  and  offers  as  the  scientific  ex- 
planation of  the  behavior  of  price,  but  it  does  not  follow 
that  knowledge  of  this  principle  is  what  is  needed  for 
shrewd  dealing  in  foreign  exchange.  Quite  the  contrary. 
Ability  to  forecast  coming  changes  in  underlying  condi- 
tions is  the  great  requisite.  For  example,  in  the  fall  of  the 
year  1912,  an  exchange  banker  must  have  been  deeply 
concerned  with  the  chances  of  a  general    European  war 


588  FOREIGN  EXCHANGE 

arising  out  of  the  crisis  in  the  Balkan  states,  and  in 
the  probable  effects  of  such  war  upon  the  securities  and 
merchandise  traffic  of  the  United  States,  and  through 
these  upon  the  exchange  market.  A  certain  New  York 
newspaper  argued  at  the  time  for  instance,  that  a  war  of 
this  character  would  not  be  likely  to  cause  Europeans  to 
dump  American  securities  upon  the  New  York  market, 
because  Europeans  would  recognize  that  our  securities  are 
especially  safe,  owing  to  the  freedom  of  this  country  from 
entanglement  in  the  war.  Another  paper  made  the  reply 
that  on  the  contrary  we  should  have  to  expect  dumping 
in  great  volume,  just  because  Europeans  could  get  cash 
out  of  our  securities.  This  is  an  example  of  a  question 
concerning  the  future  course  of  underlying  conditions.  A 
great  discharge  of  foreign-held  securities  into  the  New 
York  market  would  raise  up  a  strong  demand  for  ex- 
change to  pay  for  them,  and  thus  would  tend  powerfully 
to  elevate  exchange  rates.  All  the  time  while  any  great 
influence  such  as  this  may  be  working  out  its  effect,  the 
exchange  rate,  for  each  class  of  bills,  would  be  keeping 
to  the  figure  which  would  clear  the  market,  but  it  is  not 
this  principle  that  is  so  important  to  the  practical  dealer. 
What  he  needs  to  know  is  the  time  when  the  influence  of 
new  conditions  will  hit  the  market,  and  the  direction, 
duration  and  strength  of  the  influence. 

§  151.  The  sources  of  exchange  supply  and  demand. — The 
total  supply  of  and  inquiry  for  exchange  comes  from 
numerous  and  varied  sources,  a  conspectus  of  which  is 
shown  in  the  tables  on  pages  589-591  inclusive. 

The  ordinary  transactions  that  give  rise  to  exchange  sup- 
ply and  demand  fall  readily  into  two  main  groups,  that  is, 
(1)  commercial  and  (2)  banking  transactions.  In  nam- 
ing the  first,  we  use  the  word  "commercial  in  its  broader 
sense  covering  trade,  traffic,  and  travel  in  general,  and 
not  merely  the  export  and  import  of  merchandise.     The 


THE  THEORY  OF  EXCHANGE  RATES 


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592  FOREIGN  EXCHANGE 

distinction  between  the  commercial  and  banking  sources 
gains  force  from  the  fact  that  the  operations  of  commerce 
are  in  a  very  true  sense  the  fundamental  governing  in- 
fluences in  the  exchange  market,  while  the  banking  op- 
erations are  secondary  or  derived. 

§  152.  How  national  credits  and  debits  affect  the  market. 
— A  national  credit  may  be  defined  as  a  right  possessed 
by  a  resident  (or  by  the  government)  of  a  given  country 
to  receive  money  from  abroad.  The  right  may  be  to  re- 
ceive a  designated  quantity  of  home  money  as  is  the  case 
where  an  American  sells  merchandise  or  securities  abroad 
for  a  p»ice  stated  in  dollars ;  or  it  may  be  a  right  to  re- 
ceive a  specified  sum  of  foreign  money,  as  when  any  such 
merchandise  is  sold  for  a  price  stated  in  sterling.  In  the 
latter  case  the  holder  of  the  right  to  foreign  money  usually 
converts  it  into  home  money  simply  by  selling  foreign 
exchange  at  the  existing  rate  in  the  home  market.  A 
national  debit  is  an  obligation  imposed  upon  a  resident 
(or  the  government)  of  a  given  country  to  pay  money 
abroad,  whether,  of  course,  a  specified  amount  of  foreign 
or  of  home  money.  It  should  be  noted  a  "national"  credit 
or  debit  does  not  here  signify  merely  a  governmental  or 
state  right  or  obligation. 

The  great  body  of  national  credits  and  debits  of  a  given 
country  are  produced  by  the  commercial  and  banking 
transactions  of  private  houses  and  firms.  It  is  the  simplest 
matter  imaginable  to  tell  whether  a  given  transaction 
brings  into  being  a  national  credit  or  a  national  debit, 
for  we  can  always  tell  whether  because  of  this  transaction 
one  of  our  residents  stands  to  receive  or  stands  to  pay 
money.  In  fact,  calling  a  right  to  receive  money  a  na- 
tional credit  adds  nothing  to  our  information  regarding 
the  tendencies  of  a  given  commercial  or  banking  trans- 
action, but  merely  gives  us  a  convenient  name  for  this  right. 

There  is  a  definite  rule  or  law  of  the  effect  of  national 


THE  THEORY  OF  EXCHANGE  RATES     593 

credits  and  debits  upon  the  foreign  exchange  market.  A 
national  credit  always  works  out  its  effect  on  the  foreign 
exchanges  in  one  of  the  three  following  ways: 

(1)  It  increases  the  supply  of  foreign  exchange  for 
sale  in  the  home  market  (without  exerting  a  direct 
influence  upon  the  supply  of  or  demand  for  bills  in 
the  exchange  market   of  the  other  country). 

(2)  Or  it  exerts  no  direct  effect  upon  the  home  market 
but  instead  increases  the  demand  for  bills  in  the 
market  of  the  foreign  country,  acting  in  the  capacity 
of  a  national  debit  there  (the  national  credit  of  one 
country  being,  of  course,  always  the  national  debit 
of  some  other). 

(3)  Or  a  national  credit  may  act  both  to  increase  the 
supply  of  foreign  exchange  in  the  home  market 
and  to  increase  the  demand  for  foreign  exchange 
in  the  other  country's  market.  (A  national  credit 
has  both  these  effects  whenever  settlement  is  ar- 
ranged for  under  a  commercial  letter  of  credit  au- 
thorizing drafts  on  a  third  country;  or  whenever  the 
exporter  draws  on  the  importer  for  money  of  a  third 
country.)      (Compare  §§39  and  71.) 

It  appears  then  that  an  increase  of  the  supply  of  foreign 
exchange  in  the  home  market,  and  an  increase  of  the  de- 
mand for  foreign  exchange  in  the  market  of  the  other 
country,  are  in  some  regards  equivalents.  Either  may  be 
the  product  of  a  like  or  common  cause.  In  point  of  fact 
also,  both  are  alike  fundamentally  in  the  further  effects 
which  they  themselves  produce  or  tend  to  produce  upon 
the  gold  movements  and  discount  rates.  Thus  an  increase 
of  the  supply  of  sterling  exchange  in  New  York  tends 
to  drive  down  the  rate  for  sterling  toward  the  gold-import 
point  and  to  produce  a  gold  import  into  New  York  from 


594  FOREIGN  EXCHANGE 

London,  and  an  increase  of  the  demand  for  New  York 
exchange  in  London  lends  to  drive  np  the  rate  for  this 
exchange  there  toward  the  London  gold-export  point,  and 
to  produce  a  gold  export  from  London  to  New  York.  And 
these  two  gold  movements  are,  of  course,  the  same. 

In  a  similar  manner  a  national  debit  always  works  out 
its  effect  upon  the  foreign  exchanges  in  one  of  three  ways : 

(1)  It  may  increase  the  demand  for  foreign  exchange 
in  the  home  market  (without  directly  influencing 
the  supply  of  or  demand  for  bills  in  the  market 
of  the  other  country). 

(2)  Or  it  may  increase  the  supply  of  bills  in  the  mar- 
ket of  the  other  country  (without  directly  affecting 
the  home  market  for  foreign  exchange). 

(3)  Or  a  national  debit  may  act  both  to  increase  the  de- 
mand for  foreign  exchange  in  the  home  market 
and  to  increase  the  supply  of  foreign  exchange  in 

the  foreign  market.     (This  is  the  converse  of  case  3 
under  national  credits.) 

In  sum :  If  a  national  credit  directly  affects  the  home  mar- 
ket for  foreign  exchange  in  any  way,  it  serves  always  as 
a  source  of  supply  of  exchange,  and  its  existence  tends  to 
lower  exchange  rates  and  works  in  the  direction  of  oc- 
casioning gold  inflow.  If  a  national  debit  directly  affects 
the  home  market  for  foreign  exchange  in  any  way,  it  serves 
always  as  a  source  of  exchange  demand,  and  its  existence, 
therefore,  tends  to  raise  exchange  rates  and  works  hi  the 
direction  of  producing  a  gold  outflow. 

When  we  explain  that  an  operation  of  commerce  be- 
tween two  cities  may  be  so  settled  that  in  one  of  the  two 
there  will  be  no  effect  produced  upon  exchange  supply 
and  demand,  we  must  be  careful  to  state  only  that  there  will 
be  no  "direct"  effect.     This  implies,  of  course,  that  there 


THE  THEORY  OF  EXCHANGE  RATES     595 

may  be  an  indirect  effect  on  the  exchanges  in  the  city 
where  there  is  no  direct  effect.  If  New  York  exports 
goods  to  Paris  and  if  settlement  is  accomplished  by  New 
York's  drawing  exchange  on  Paris,  it  is  true  that  while 
this  operation  works  no  direct  effect  upon  the  Parisian 
foreign  exchange  market,  it  does  tend  to  produce  an  in- 
direct effect  in  that  market,  especially  upon  the  Parisian 
rates  of  exchange  on  New  York.  For  the  New  York  oper- 
ation takes  part  in  producing  a  general  exchange  situation 
which,  through  arbitrage  tends  to  react  upon  the  exchange 
market  of  Paris  itself.  That  is  to  say,  in  the  interest  of 
accuracy  we  must  restrict  certain  preceding  assertions  to 
the  ''direct"  effects  of  the  given  commercial  operation  upon 
the  given  exchange  market. 

Returning  now  to  the  table  giving  the  classification  of 
sources  of  exchange  supply  and  demand,  we  find  the  first 
source  listed  is  "commerce  in  merchandise."  This  has 
reference  to  the  commerce  in  merchandise  of  any  given 
country.  The  second  column  of  the  table  indicates  that  the 
country's  exports  of  goods  create  a  supply  of  drafts  in  its 
own  exchange  market.  This  is  true,  provided  the  export  is 
settled  for  in  any  way  that  has  a  direct  effect  upon  the 
home  market  for  exchange.  If  settled  in  some  other  way, 
this  same  export  will,  acting  as  the  other  country's  im- 
port, create  a  demand  for  exchange  in  that  other  country. 
Such  a  demand  for  exchange  is  what  is  indicated  in  the 
third  column  of  the  table  by  the  item  "drafts  needed  to 
pay  for  imports  of  merchandise."  Similarly  the  given 
country's  imports  either  directly  affect  its  own  exchange 
market  and  produce  a  demand  for  bills,  or  they  act  as  the 
exports  of  the  other  country  and  produce  a  supply  of  ex- 
change  in  it,  serving  as  its  national  credit. 

Special  features  of  the  securities  traffic. — The  initial 
effect  of  an  export  of  securities  is  precisely  the  same  as 
that  of  an  export  of  merchandise,  namely,  to  produce  a 


596  FOREIGN  EXCHANGE 

national  credit.  But  most  bonds  and  stocks  that  attain 
the  dignity  of  international  purchase  and  sale,  pay  inter- 
est and  dividends.  Thus  while  the  sale  of  our  securities 
abroad  creates  a  national  credit  in  the  first  instance,  the 
interest  charges  due  the  foreign  holder  produce  a  stream 
of  lesser  national  debits.  Supposing  these  national 
credits  and  debits  to  be  settled  for  by  sales  or  purchases 
of  exchange  in  our  own  market,  as  is  the  dominant  prac- 
tice in  fact,  instead  of  by  the  buying  and  selling  of  ex- 
change abroad,  the  sale  of  a  security  to  a  foreigner  pro- 
duces a  supply  of  exchange,  while  the  necessity  of  paying 
him  interest  produces  thereafter  an  intermittent  and  in 
general  regularly  recurring  lesser  demand  for  exchange. 
'  The  repurchase,  or  the  discharge  of  foreign-held  securities 
at  maturity,  occasions  of  course  a  large  single  item  of  de- 
mand for  exchange,  but  has  the  further  effect  of  terminat- 
ing the  intermittent  demand  for  bills  to  pay  interest 
charges,  j 

§  153.  The  several  spreads  in  the  group  of  rates  on  a 
given  country. — As  we  pursue  the  theory  of  exchange 
rates  from  this  point  forward  we  run  into  matter  of  in- 
creasing technicality  and  difficulty.  It  will  not  be  the  at- 
tempt of  this  book  to  carry  investigation  or  analysis  to 
the  farthermost  regions  which  the  purely  scientific  spirit 
might  seek  to  explore.  And  what  remains  to  be  stated 
will  have  to  be  laid  down,  at  least  in  places,  in  a  manner 
somewhat  arbitrary  and  without  a  full  showing  of  reasons. 
The  following  are  actual  quotations  for  bankers'  draw- 
ings on  an  ordinary  day  some  time  before  the  abnormali- 
ties of  the  war  injected  themselves  into  the  exchanges. 

Sterling 

Cables  4.8765 

Demand  4.8715 

Sixty  Days  4.83 

Ninety  Days  4.8160 


THE  THEORY  OF  EXCHANGE  RATES     597 

The  group  of  rates  in  one  given  country  (e.g.  the  United 
States)  on  some  other  given  country  (e.g.  England)  rise 
and  fall  together  in  a  general  way — acting  to  a  degree 
like  a  constellation — but  the  gaps  or  spacings  between  the 
members  of  the  group  are  not  in  truth  unchangeable.  It 
is  our  next  problem  to  make  a  summary  of  the  causes  or 
influences  which  govern  these  spacings  or  "spreads." 

There  are  three  primary  or  true  spreads  existing  be- 
tween the  rates  given  in  the  last  preceding  table.  These 
are  (1)  the  spread  between  the  cable  and  the  sight  rate,  (2) 
that  between  the  sixty-days'  rate  and  the  sight  rate,  and 
(3)  that  between  the  ninety-days'  rate  and  the  sight  rate. 
All  other  spaces  or  gaps  such  as  that  between  the  ninety- 
days'  and  the  cable  rates,  or  between  the  ninety  and  the 
sixty-days'  rates,  are  what  we  may  call  secondary  or  false 
spreads.  To  explain  this  discrimination,  certain  factors 
govern  more  or  less  rigidly  the  relative  positions  of  the 
rates  in  any  one  national  group,  such  as  the  sterling  group. 
Now,  taking  the  process  of  rate-making  as  it  actually  goes 
on  in  the  real  market,  these  factors  govern  or  determine 
only  those  spreads  which  we  have  just  designated  as 
primary  or  true.  It  is  true  the  fixing  of  these  spreads  de- 
termines the  configuration  of  the  whole  group.  The  point 
is  that  the  group  configuration  is  determined  by  the  fix- 
ation of  these  particular  spreads  and  no  others,  and  that 
the  other  gaps  or  false  spreads  become  what  they  are  sec- 
ondarily and  merely  in  consequence  of  this  fixation. 

Every  primary  spread  is  one  between  the  sight  rate  on 
the  one  hand  and  some  other  rate  on  the  other  hand.  Each 
of  the  other  rates  of  a  group  is  tied  directly  (whether  in  a 
loose  or  tight  relation)  to  the  sight  rate,  and  there  are  no 
other  tics.  The  bids  and  offers  of  other  rates  are  com- 
puted from  the  sight  rate  as  a  basis,  but  the  sight  rate 
itself  is  not  computed  from  any  oilier  r;itc  but  is  deter- 
mined independently  in   the   market  by   the  conditions  of 


598  FOREIGN  EXCHANGE 

supply  and  demand.  As  will  be  shown  later,  a  supply  of 
or  demand  for  telegraphic  transfers  or  long  exchange  con- 
verts sooner  or  later  in  regular  course  into  a  supply  of 
or  demand  for  sight  exchange,  and  thus  the  sight  rate  be- 
comes what  might  be  called  the  focal  rate  of  exchange  as 
well  as  the  common  basis  of  reference  for  the  other  rates. 
The  notion  that  the  telegraphic  transfer  rate  is  in  some 
sense  the  fundamental  or  pure  rate  of  exchange  has  a 
certain  plausibility.  Without  attempting  to  analyze  this 
notion  exactly,  we  perceive  that  it  carries  the  suggestion 
that  other  rates  of  exchange,  including  the  sight  rate,  hang 
or  depend  from  the  telegraphic  transfer  rate,  each  being 
lower  by  an  amount  governed  by  discount  or  interest. 
Taking  actual  determinations  or  adjustments  of  rates  as 
they  take  place  in  the  real  market,  this  suggestion  is  in- 
correct and  will  always  remain  incorrect.  Sight  bills  are 
never  discounted  in  any  real  sense.  They  are  not  in  fact 
bought  and  sold  under  a  quoted  discount  rate  and  never 
will  be.  Again,  the  rates  for  long  bills  are  not  computed 
from  the  telegraphic  transfer  rate  and  it  seems  safe  to  say 
they  never  will  be.5  The  truth  of  the  matter  is  the  long 
rates  are  (times  of  financial  turmoil  apart)  rather  pre- 
cisely determined  in  reference  to  the  sight  rate,  while  the 
cable  rate  is  to  one  side  being  related  more  loosely  to  the 
sight  rate,  and  being  related  to  the  others  only  through 
the  sight  rate.  The  claim  of  the  sight  rate  to  be  basic  in 
the  group  is  further  substantiated  by  the  fact  that  it  is 
the  only  rate  in  which  both  gold-export  and  gold-import 
points  can  be  located.  There  can  be  a  gold-import  point 
in  the  rate  for  telegraphic  transfers,  but  there  can  be  no 
gold-export  point  in  it.  Telegraphic  transfers  on  London 
cannot  be  sold  in  New  York  to-day  against  a  gold  export 

5  Except  possibly  in  an  undiscriminating  manner  in  cases  where, 
owing  to  a  short  distance  between  the  two  countries  concerned,  the 
sight  and  telegraphic  transfer  rate  are  nearly  the  same. 


THE  THEORY  OF  EXCHANGE  RATES     590 

of  to-day,G  and  it  is  not  the  cable  rate  of  to-day,  but  the 
sight  rate  which  determines  the  feasibility  of  the  shipment. 
Thus  when  we  say  that  the  exchange  rate  is  usually  con- 
fined between  the  gold  points,  it  is  the  sight  rate  of  which 
we  speak. 

§  154.  The  spreads  for  the  long  rates. — On  earlier  pages 
we  have  considered  the  methods  of  computing  the  buying 
rates  for  long  bills  and  have  also  discussed  the  factors 
governing  investment  in  these  instruments.  It  remains  to 
bring  these  matters  together  and  summarize  them.  The 
spread  between  the  sight  and  a  given  long  sterling  rate 
depends  upon  the  contemporary  discount  rate  as  major 
factor  and  upon  stamp  tax,  commission,  and  profit,  as 
minor  factors.  In  an  ordinary  case  perhaps  94 o  of  the 
spread  will  be  due  to  discount.  The  question  arises, 
which  discount  rate  is  it  that  governs,  that  in  the  drawing 
city  (e.g.  New  York)  or  that  in  the  domicile  city  (e.g.  Lon- 
don). The  answer  may  be  formulated  in  the  following 
rule.  When  the  discount  rate  in  the  domicile  city  is  the 
lower  of  the  two,  it  alone  governs  that  part  of  the  spread 
due  to  discount.  When  the  discount  rate  in  the  drawing 
city  is  the  lower,  it  may  affect,  though  it  will  not  fully 
govern  the  spread.  Stating  this  in  a  slightly  different 
form,  the  spread  can  never  be  greater  than  the  figure 
proportionate  to  the  discount  rate  in  the  domicile  city 
but  it  may  be  less  than  this  when  the  discount  rate  in  the 
drawing  city  is  lower,  though  it  will  not  become  much 
less. 

Continuing  with  illustrations  drawn  from  the  New  York 
market  for  sterling  exchange,  if  the  London  money  rate 
(applicable  to  the  type  of  long  sterling  in  question)  is 
3%  and  the  New  York  rate  is  higher,  the  London  rate  will 
govern  exclusively,  whether  the  New  York  rate  is  4,  5, 

o  The  case  of  gold  export  with  an  interest-free  advance  on  the 
other  side  is  an  exception  to  this  statement. 


600  FOREIGN  EXCHANGE 

or  6%,  and  it  makes  positively  no  difference  which  of 
these  is  the  New  York  rate.  When  the  rate  for  sight 
sterling  is  4.85  and  the  London  discount  rate  for  a  certain 
class  of  merchants'  ninety  days'  bills  is  3%,  the  buying 
rate  for  these  bills  would  be  4.8070  to  yield  the  purchasing 
banker  a  profit  of  nearly  Vnf;  per  pound.7  The  full  spread 
is  then  4.30^.  Money  rates  in  New  York  being  higher 
than  in  London,  the  best  use  the  banker  can  make  of  these 
bills  is  immediate  discount  on  arrival  in  London.  In  this 
use  they  are  worth  4.8070  per  pound  and  would  be  worth 
no  less  whatever  be  the  height  to  which  New  York  money 
rates  ascend.  Nothing  is  changed  so  long  as  demand  ster- 
ling can  be  sold  at  4.85  and  London  will  discount  (for 
arrival)   at  3%. 

Let  us  suppose  that  the  money  rate  in  New  York  be- 
comes the  lower.  To  obtain  a  strong  case  suppose  that  no 
more  than  2%  can  be  had  in  our  market  for  short-term 
employment  of  money  in  ways  equally  good  with  invest- 
ment in  sterling  bills  of  the  kind  we  are  considering.  As- 
sume further  that  the  London  discount  rate  for  these  bills 
is  now  4%.  Under  these  conditions  it  is  quite  possible 
that  the  spread  will  no  longer  follow  the  London  discount 
rate.  On  the  other  hand,  however,  it  is  very  unlikely  it 
will  be  governed  rigidly  by  the  New  York  money  rate  of 
2%.  To  explain:  if  the  spread  continued  to  be  propor- 
tionate to  the  London  money  rate,  our  bankers  would  be 
able  to  make  about  4%  by  investing  in  long  sterling,  pro- 
vided the  rate  for  sight  sterling  should  remain  as  high  at 
the  termination  as  at  the  beginning  of  the  investment.8 
Therefore  if  the  indications  for  the  course  of  sight  sterling 
seem  favorable  it  is  probable  the  banks  will  compete  for 
these  sterling  bills.  If  they  yield  4%  while  corresponding 
domestic  investments  give  but  2%,  bidding  is  likely  to  be 

7  Compare  the  computation  on  p.  266. 
s  Compare  §§  80  and  81. 


THE  THEORY  OF  EXCHANGE  RATES     601 

sufficiently  spirited  to  drive  the  rate  for  them  up  at  least 
a  little  distance,  and  so  decrease  the  spread.  It  is  safe 
to  say  this  rise  will  never  go  so  far  as  to  make  the  spread 
correspond  to  the  2%  money  rate  of  New  York,  and  in 
fact  it  is  improbable  it  will  go  more  than  a  small  propor- 
tion of  this  distance.  The  reason  is  the  risk  of  exchange. 
Thus  we  say  that  when  the  money  rate  is  lower  in  the 
drawing  than  in  the  domicile  city,  it  affects  but  does  not 
fully  govern  the  spread.9 

§  155.  The  telegraphic  transfer  spread. — The  rate  for 
telegraphic  transfers  moves  at  a  variable  distance  above 
the  sight  rate  owing  to  the  fact  that  the  order  by  wire 
results  in  an  earlier  payment  of  funds  abroad  than  does 
the  demand  draft.  The  cost  of  the  telegram  does  not  en- 
ter into  the  cable  rate  proper.  Thus  the  cable  spread  is 
a  phenomenon  of  discount  or  interest.  It  cannot,  how- 
ever, be  explained  in  quite  the  same  manner  as  the  other 
spreads,  though  the  latter  are  also  based  primarily  upon 
discount,  and  it  does  not  in  practice  follow  the  dictates  of 
any  one  distinguishable  money  rate  with  anything  like 
the  fidelity  with  which  the  other  spreads  obey  the  money 
rates  that  control  them. 

Prior  to  the  present  war,  the  greatest  and  the  smallest 
cable  spreads  in  the  rates  for  sterling  recorded  in  New 

o  The  rule  formulated  in  this  section  was  stated  by  the  eminent 
Dutch  economist,  N.  G.  Pierson,  in  his  "Principles  of  Economies'' 
(translation),   London,   1902,  pp.  527-9  of  vol.    1. 

At  times  when  the  money  rates  are  lower  in  the  drawing  city 
(e.g.  New  York)  it  is  possible  there  will  be  few  or  no  finance  bills 
being  offered,  but  long  bills  drawn  by  merchants  on  foreign  bankers 
and  merchants  will  continue  to  come  forth  in  the  usual  volume. 
It  is  to  be  kept  in  mind  that  up  to  the  time  of  the  outbreak  of  the 
war,  it  was  as  a  matter  of  fact  a  rare  occasion  for  money  rates  to  be 
lower  in  New  York  than  in  London,  and  thus  as  far  as  experience 
goes,  the  spreads  for  long  sterling  in  New  York  have  been  governed 
by  the  London  discount  rate.  For  a  time  during  the  panic  of  1907, 
it  must  be  said,  they  seemed  to  be  governed  by  nothing  in  particular. 


602  FOREIGN  EXCHANGE 

York,  at  least  within  the  last  decade  of  the  period,  were 
experienced  at  the  time  of  the  panic  of  1907  and  in  the 
weeks  of  financial  stagnation  immediately  following.  It  is 
doubtful  if  we  can  tell  from  newspaper  reports  precisely 
what  the  extreme  spread  was  on  days  of  great  fluctuations. 
Some  reports  quote  only  one  sight  rate  and  one  cable  rate 
for  each  day,  but  the  better  ones  give  the  highest  and 
lowest,  or  perhaps  the  opening  and  closing  rates.  Each 
of  the  monthly  issues  of  the  Bank  and  Quotation  Supple- 
ment of  the  Commercial  and  Financial  Chronicle  (New 
York)  has  a  table  showing  the  high  and  low  rates  for  the 
chief  classes  of  sterling  exchange  for  each  business  day 
of  the  preceding  month.  The  following  data  are  from  the 
Chronicle's  table  for  November,  1917 : 10 

Nov.  7.  Sight,  4.86    -4.86*4     Cables,  4.89^4-4.90. 

Nov.  13.         Sight,  4.86i/4-i.86y2.     Cables,  4.90    -4.90y4. 
Nov.  16.  Sight,  4.87%-4.88.         Cables,  4.903/4-4.9iy2. 

Examination  of  the  reports  of  such  papers  as  the  New 
York  Times  or  the  Wall  Street  Journal  shows  they  are 
likely  to  differ  from  the  Chronicle  and  from  each  other 
with  respect  to  the  exact  figures  which  have  been  quoted 
on  a  given  day,  especially  if  the  market  has  been  change- 
able. Taking,  howrever,  the  figures  copied  above  from  the 
Chronicle,  and  assuming  that  the  highest  recorded  cable 
rate  was  made  at  the  same  time  of  day  as  the  highest  sight 
rate,  we  discover  the  following  spreads : 

Nov.  7.  Sight,  4.86%.  Cables,  4.90.  Spread  .0375,  or  3^  per  £ 
Nov.  13.  Sight,  4.86%.  Cables,  4.90%.  Spread  .0375,  or  3VJ  per  £ 
Nov.  16.    Sight,  4.88.       Cables,  4.91%.  Spread  .0350,  or  3y2tf  per  £ 

The  rates  for  November  16th  are  of  interest  as  showing 
the  highest  price  for  cables  reached  during  the  period  of 
the   panic.     The    Chronicle's    table    for   August,    1908,    a 

10  Bank  and  Quotation  Supplement,  December,  1907,  p.  22. 


THE  THEORY  OF  EXCHANGE  RATES     603 

month  in  the  ensuing  period  of  stagnation,  contains  these 
quotations : 

Aug.  17.     Sight,  4.8650— 4.8660,  Cables,  4.8660— 4.8665. 

This  shows  a  spread  of  .0005,  but  perhaps  it  was  never 
actually  below  .0010,  which  is  a  figure  found  in  a  num- 
ber of  published  reports  for  various  days  in  this  period. 

From  these  data  it  would  appear  that  the  cable  spread  has 
within  a  period  of  ten  months  varied  from  375  points  to 
10  points,  or  from  3%^  to  Mo  of  1^  per  pound.  The  great- 
est spread  was  37^  times  the  smallest. 

On  August  1st,  1914,  just  after  the  outbreak  of  the  great 
war,  the  rate  in  New  York  for  sterling  cables  touched  the 
astonishing  figure  of  $7.00  per  pound.  Extensive  trans- 
actions did  not  take  place  at  this  rate,  but  it  is  reported 
as  one  actually  reached.  For  the  same  day,  the  Com- 
mercial and  Financial  Chronicle  reports  the  sight  rate  as 
having  been  at  $5.50  to  $6.00  per  pound.  No  doubt  some 
sales  actually  took  place  at  these  figures.  If  so,  there  ap- 
pears to  have  been  a  cable  spread  of  from  $1.00  to  $1.50 
per  pound,  the  abnormality  of  which  is  easily  appreciated 
by  comparing  it  with  an  ordinary  spread  of  about  Vi§.  On 
August  1st  and  for  several  days  thereafter  the  exchange 
market,  or  exchange  mechanism  if  one  prefers,  was  really 
not  functioning.  Later  it  began  to  operate  somewhat  more 
smoothly,  but  it  has  not  been  running  normally  since,  from 
that  day  to  the  present.11  Since  August,  1914  there  have 
been  no  cable  spreads  as  great  as  those  of  the  autumn  of 
1907,  though  they  have  averaged  greater  than  those  of 
ordinary  times,  having  been  at  or  near  1Y  much  of  the 
time  during  the  last  three  years.  While  it  is  not  difficult 
to  point  out  the  circumstances  which  made  possible  the 
colossal  spread  of  August  1st,  1914,  it  would  be  absurd 
to  try  to  relate  it  to  any  existing  discount  or  interesl  rate, 

ii  The  spring  of  1919. 


004  FOREIGN  EXCHANGE 

and  we  shall  not  attempt  to  bring  it  under  any  set  rule 
or  law.  A  spread  of  $1  above  a  sight  rate  of  $6,  would 
correspond  to  an  interest  rate  of  about  1,000%  per  annum, 
if  sight  bills  were  payable  in  London  a  week  later  than 
cables.  In  this  condition  mails  were  not  in  fact  getting 
over. 

Rates  for  call  and  short  term  money  have  undoubtedly 
much  influence  on  cable  spreads,  but  statistical  studies,  at 
least  of  extraordinary  times,  will  show  a  very  low  degree 
of  correlation  between  the  two.  On  October  24th,  1907, 
the  call  loan  rate  reached  100%  per  annum  in  New  York, 
while  the  cable  spread  of  the  day  was  about  145  points. 
On  November  7,  1907,  the  cable  spread  appears  to  have 
climbed  to  375  points,  while  call  money  was  at  the  high- 
est at  20%  in  New  York  and  at  5%  in  London.  Dear 
call  money  of  course  is  associated  in  a  general  way  with 
a  great  spread,  but  only  in  a  general  way.  On  August 
17,  1908,  when  the  spread  was  10  points,  the  call  rate  was 
at  1%  in  New  York  and  at  %%  in  London. 

If  we  attempt  now  to  construct  a  theory  of  the  cable 
spread,  by  which  we  mean  nothing  more  or  less  than  a 
general  explanation  of  it,  we  find  that  the  subject  is  best 
treated  under  three  headings,  namely:  (1)  the  theoretical 
minimum  (or  lowest  possible  rational)  spread,  (2)  the  nor- 
mal spread,  and  (3)  the  spread  under  the  influence  of 
necessitous  buying. 

(1)  The  muiiiiuon  spread. — If  we  arbitrarily  assume 
that  sellers  of  cables  have  surplus  funds  both  at  home 
and  in  the  foreign  balance  and  are  willing  to  sell  this 
form  of  exchange  so  cheap  that  they  merely  make  no  losses 
from  the  operation,  and  that  there  are  no  buyers  whose 
commitments  abroad  force  them  to  procure  cables,  in  other 
words,  that  all  buyers  could  make  demand  drafts  serve, 
we  have  the  conditions  under  which  the  spread  might  fall 
to  its  very  minimum.     This  minimum  would  be  governed 


THE  THEORY  OF  EXCHANGE  RATES     605 

by  the  foreign  city's  deposit  allowance  rate  or  rate  of  in- 
terest paid  on  bankers'  balances. 

Treating  as  usual  of  the  New  York  market  for  sterling, 
let  us  assume  the  following: 

Sight  rate    4.85 

London  deposit  allowance  rate 1% 

Mail  time,  New  York  to  London 6  days 

A  banker  buying  a  sterling  cable  instead  of  a  demand 
draft  would  at  the  least  make  a  gain  (in  sterling  in  Lon- 
don) of  6  days'  interest  at  the  deposit  allowance  rate. 
Taking  6  days  as  about  Yeo  of  a  year,  a  pound  remitted 
by  cable  would  become  £1  plus  %0  of  1%  of  £1,  by  the  day 
when  a  sight  draft  for  £1  could  arrive  and  produce  merely 
£1.  Thus  £1  of  cable  transfer  is  as  a  purchase  worth  at  a 
minimum  Veo  of  1%  more  than  £1  of  sight  draft.  %o  of 
1%  of  4.85  is  .0008,  and  therefore  when  a  sight  draft  can 
be  bought  for  4.85  a  cable  is  as  good  a  purchase  at  4.8508, 
the  spread  being  8  points.  The  spread  could  hardly  then 
fall  below  8  points,  for  if  it  did  cables  would  become  bet- 
ter purchases  than  sight  drafts  even  for  those  who  had  no 
special  need  for  cables  as  such,  and  all  the  demand  for 
sight  sterling  ought  to  shift  entirely  to  cables.  Hence 
the  sight  rate  could  not  get  closer  in  to  the  cable  rate 
than  8  points. 

On  the  other  side  the  supply  of  cables  would  neces- 
sarily disappear  if  the  spread  should  fall  below  8  points, 
because  the  seller  of  this  form  of  exchange  would  be- 
gin actually  to  lose  money  if  he  sold  at  a  rate  lower  than 
within  8  points  of  the  sight  rate.  This  gives  us  a  second 
sufficient  reason  why  the  spread  could  not  fall  below  8 
points. 

Since  rates  commonly  move  only  in  intervals  of  5  points 
at  a  time,  the  theoretically  indicated  cable  spread  of  8 
points  would   probably   become    10   points,   and   with   the 


606  FOREIGN7  EXCHANGE 

siprlit  rate  at  4.85  and  the  London  deposit  allowance  rate 
at  1%  the  theoretical  minimum  cable  rate  would  be  4.8510. 
These  speculations  do  not  appear  altogether  idle  when  we 
look  at  the  cable  spreads  of  August,  1908.  During  that 
entire  month  the  Bank  rate  stood  at  2&%  in  London  and 
the  deposit  allowance  rate,  commonly  paid,  at  1%,  and 
according  to  the  Commercial  and  Financial  Chronicle's 
table  12  there  was  one  day  when  the  spread  was  10  points 
(if  it  was  not  lower)  and  there  were  eight  days  when  it 
was  but  15  points.  Throughout  July  of  the  same  year, 
the  deposit  allowance  rate  was  likewise  at  1%,  and  there 
were  four  days  when  the  spread  was  10  points  and  four 
when  it  was  15. 

(2)  The  normal  spread. — An  exchange  bank  may  make 
it  a  regular  department  of  its  business  to  supply  the  mar- 
ket with  cables,  though  only  larger  banks  and  exchange 
houses  are  likely  to  do  this.  The  supply  of  cables  is 
usually  competitive,  but  it  is  to  be  supposed  that  sellers 
ordinarily  should  be  able  to  secure  from  this  line  of  busi- 
ness returns  covering  interest  on  any  funds  especially 
employed  in  it  and  also  a  remuneration  for  placing  facili- 
ties at  the  disposal  of  others,  substantially  equal  to  the 
similar  remunerations  procurable  under  competition  in 
other  lines  of  foreign  and  domestic  banking.  The  latter 
remuneration  is  likely  to  go  by  the  name  of  "profits"  and 
no  objection  to  this  use  of  words  is  raised  here.  In  other 
words,  selling  cables  must  be  expected  usually  to  yield  in- 
terest and  profits  as  great  as  those  obtainable  in  alternative 
lines  of  employment  of  money  funds  and  banking-house 
facilities. 

The  seller  of  a  cable  who  covers  his  sale  with  the  pur- 
chase of  another  cable  is  of  course  not  adding  to  the  sup- 
ply on  the  market,  but  is  really  acting  as  an  intermediary 
for  the  convenience  of  some   customer.     Examination   of 

12  Bank  and  Quotation  Supplement  for  September,  1908,  p.  22. 


THE  THEORY  OF  EXCHANGE  RATES     607 

this  operation  will  lead  us  to  no  conclusions  regarding  the 
cable  spread,  and  so  we  set  it  aside.  The  bank  which  con- 
tributes to  the  original  supply  must  ultimately  cover  its 
sales  of  cables  by  purchases  of  sight  drafts  (or  their 
equivalent  in  discountable  long  bills).  But  if  a  given  lot 
of  sight  drafts  are  to  serve  as  cover  for  cables  sold  to-daj' 
they  must  have  been  bought  and  forwarded  about  six  days 
ago  (from  New  York).  Any  lot  forwarded  at  a  later  time 
than  this  cannot  be  in  London  to-day. 

If  then  a  New  Y'ork  bank  sells  £10,000  of  cables  to-day 
it  should  charge  the  operation  with  the  cost  of  £10,000  of 
sight  drafts  bought  six  days  ago.  Dollars  were  expended 
six  days  ago  and  a  return  of  the  fund  in  dollars  is  re- 
ceived to-day  from  the  sale  of  the  cables.  The  return 
must  exceed  the  outlay  if  it  is  to  afford  interest  and  profit. 
In  the  present  connection  we  shall  count  "profit"  as  con- 
taining everything  in  the  way  of  gain  above  the  interest, 
so  that  profit  contains  a  contribution  to  the  overhead  costs 
of  banking.  The  operation  is  chargeable  with  six  days 
interest  at  the  rate  which  can  be  had  by  some  alternative 
employment  of  the  bank 's  funds,  substantially  equivalent  in 
point  of  security  and  liquidness.  Unless  it  yields  this  it 
is  not  worth  undertaking,13  and  only  when  it  yields  some- 
thing in  excess  of  this  can  it  be  said  to  afford  a  profit.  Per. 
haps  the  nearest  alternative  employment  of  funds  is  in  call 
loans  on  good  collateral. 

Suppose  then  first  that  the  call  loan  rate  is  4%,  or  more 
fully,  that  this  rate  lias  averaged  4%  during  the  last  six 
days,  and  suppose  further  that  £10,000  of  demand  drafts 
were  bought  six  days  ago  at  4.85,  costing  thus  $48,500. 
Suppose  also  that  a  profit  of  15  points  is  required.     The 

is  Except  on  the  theory  licit  while  it  dues  nol  pay  all  its  own 
costs  it  may  be  justified  as  attracting  other  business  to  the  bank 
which  is  self-remunerative.  This  appears  a  questionable  justifi- 
cation. 


608  FOREIGN  EXCHANGE 

£10,000  of  cables  ought  then  to  sell  at  a  rate  determined 
as  follows : 

Sight  rate  of  6  days  ago 4.85 

Outlay    $48,500.00 

}6oth  of  1  year's  interest  on  this  at  4% 32.33 

Xo-profit  selling  price $48,532.33 

No-profit  rate  4.8532 

Profit  required   (15  points)    .0015 

Required  selling  rate 4.8547 

Nearest  standard  rate  above 4.8550 

Theoretical  normal  spread  (call  money  at  4%) .        50  points 

This  spread  is  one  between  the  cable  rate  of  a  given  da}* 
and  the  sight  rate  6  days  earlier.  But  the  cable  spread 
as  ordinarily  understood  is  the  gap  between  the  cable 
and  sight  rates  of  the  same  day  or  moment.  Assuming 
that  the  sight  rate  moves  far  enough  during  the  six  days, 
the  preservation  of  a  natural  spread  between  the  cable 
and  past  sight  rate  will  mean  the  establishment  of  an  un- 
natural one  between  it  and  the  contemporary  sight  rate. 
Thus  if  the  sight  rate  were  4.85  six  days  ago  and  4.86 
to-day,  and  if  the  cable  rate  of  to-day  were  50  points  above 
the  past  sight  rate,  it  w^ould  be  50  points  below  the  pres- 
ent sight  rate,  which  would  indeed  be  absurd.  If,  on  the 
other  hand,  cables  were  raised  to  50  points  above  the  pres- 
ent sight  rate,  they  would  be  150  points  above  the  past 
one.  As  a  point  of  fact,  the  cable  rate  is  related  primarily 
to  the  contemporary  rather  than  the  week-old  sight  rate, 
and  only  a  slight  study  of  market  reports  will  be  required 
to  show  this.  What  happens  in  practice  would  seem  to 
be  that  the  spread  which,  as  a  matter  of  cost  accounting 
in  the  individual  instance,  should  be  added  to  the  past 
sight  rate,  is  added  to  the  contemporary  sight  rate  in- 
stead.    The  adoption  of  this  policy  means  a  loss  to  sellers 


THE  THEORY  OF  EXCHANGE  RATES     609 

of  cables  on  days  when  the  sight  rate  is  lower  than  a  week 
earlier  and  a  counterbalancing  gain  on  days  when  it  is 
higher.  It  allows  the  seller  the  required  interest  and 
profits  on  the  average  or  in  the  long  run,  and  has  the  great 
advantage  of  making  the  relation  between  contemporary 
cable  and  sight  rates  more  stable.  A  regular  and  con- 
tinuing business  in  cables  could  hardly  be  conducted  on 
any  other  plan,  for  buyers  of  this  form  of  exchange  would 
avoid  it  to  the  utmost  if  the  rate  for  it  were  to  have  too 
capricious  a  relation  with  the  contemporary  demand  rate. 

The  foregoing  seems  as  satisfactory  a  theory  of  the  nor- 
mal cable  spread  as  can  be  constructed.  It  makes  this 
spread  depend  chiefly  upon  the  rate  for  call  or  very  short- 
term  money  in  the  place  where  the  cables  are  sold.  But 
only  a  very  rough  correlation  between  the  two  will  be 
found  in  fact.  The  correlation  might  be  greater  if  the 
call  rate  were  itself  a  stabler  quantum.  It  must  be  kept 
in  mind  that  a  call  rate  of  3%  is  twice  as  high  as  one  of 
V/2%,  and  the  call  rate  may  at  times  be  doubled  or  cut 
in  half  in  the  course  of  an  hour.  The  economic  theorist 
who  maintains  that  cost  of  production  sets  the  normal 
value  of  freely  producible  goods  does  not  mean  to  assert 
that  the  market  value  will  always  in  fact  rest  at  normal 
value.  The  claims  of  the  theoretical  norm  here  advanced 
must  be  put  even  more  modestly  than  the  claims  of  the 
normal  value  of  goods.  The  more  stable  the  sight  ex- 
change rate  and  the  call  money  rate  and  the  less  necessitous 
the  demand  for  cables,  the  more  nearly  we  should  expect 
the  actual  cable  spread  to  conform  to  the  normal  indicated. 

(3)  We  have  attempted  to  describe  the  factors  which 
set  the  very  minimum  cable  spread  and  also  what  we  have 
assumed  the  right  to  call  the  normal  spread.  It  remains 
to  discuss  the  maximum.  Concerning  this  it  seems  im- 
possible to  advance  any  very  definite  theory.  Naturally 
maximum  spreads  will  be  experienced  under  the  pressure 


610  FOKKKIN    KXCllAXGE 

of  necessitous  buying.  Even  under  ordinary  conditions 
it  is  probable  most  buyers  of  cables  must  procure  them, 
because  of  having  allowed  the  time  to  run  by  when  they 
could  discharge  their  foreign  commitments  by  means  of 
drafts  forwarded  by  mail.  Nevertheless  the  cable  spread 
ordinarily  represents  or  corresponds  to  a  moderate  rate  of 
interest.  The  very  fact  that  experienced  mercantile, 
brokerage,  and  banking  houses  will  under  usual  conditions 
permit  themselves  to  get  into  a  position  where  they  must 
find  cables,  shows  that  they  feel  safe  in  counting  upon 
reasonable  rates.  But  the  present  question  is,  what  fac- 
tor or  factors  will  set  the  upper  limit  to  the  cable  spread 
in  case  some  unusual  financial  condition  precipitates  an 
extraordinar}-  and  helpless  demand  for  them.  It  would 
seem  that  there  is  nothing  more  to  be  said  than  that  as 
the  spread  increases,  or  the  cable  rate  climbs  upward  from 
the  sight  rate,  the  less  necessitous  elements  in  the  demand 
will  fall  away  and  certain  extraordinary  supplies  will  be 
brought  forth.  Some  of  the  intending  buyers  may  be  able 
to  arrange  by  wire  for  a  postponement  of  their  foreign 
commitments,  or  may  be  able  to  effect  a  foreign  loan  by 
wire  to  take  care  of  them.  Some  sellers  may  begin  to 
offer  cables  at  the  expense  of  overdraft  in  their  accounts 
in  London.  Some  may  make  arrangements  by  wire  for 
extraordinary  credits  against  which  to  make  sales.  Very 
likely  a  considerable  fresh  supply  will  come  from  the 
arbitragers.  But  the  question  remains,  between  the  neces- 
sitous demand  and  the  forced  supplies  what  maximum  rate 
can  come  forth?  The  general  principle  may  be  laid  down 
that  the  ascent  of  the  spread  will  be  stopped  at  the  point 
where  the  increasing  offers  of  cables  become  equal  to  the 
declining  bids,  or  where  the  increasing  amount  seeking 
sale  becomes  equal  to  the  declining  amount  sought  by 
buyers.  But  this  principle,  that  of  the  "equalization  of 
supply  and  demand"  can  be  of  very  little  utility  to  the 


THE  THEORY  OF  EXCHANGE  RATES     611 

dealer  who  desires  to  estimate  the  actual  figure  to  which 
cables  will  in  some  instance  probably  ascend,  though  it 
has  a  place  in  the  theoretical  explanation  of  the  phenom- 
enon. To  tell  one  that  when  a  weight  is  suspended  by  a 
coil  spring  the  spring  will  be  extended  until  its  upward 
pull  becomes  equal  to  the  downward  "pull  of  gravity"  on 
the  weight  (unless  the  spring  breaks  meanwhile),  will  not 
of  itself  enable  him  to  prophesy  as  to  the  actual  length 
to  be  attained  by  the  spring.  That  is,  this  mere  principle 
of  the  equalization  of  stresses  without  concrete  data  yield 
no  concrete  results,  and  a  similar  observation  holds  of  the 
principle  of  the  "equalization  of  supply  and  demand." 

§  156.  Arbitrage  and  the  interrelation  of  rates. — We  turn 
now  from  the  interrelation  of  rates  within  a  single  na- 
tional group,  such  as  the  group  of  sterling  rates  in  New 
York,  to  the  interrelations  among  rates  in  or  on  different 
countries,  as  determined  by  arbitrage  in  exchange. 

Consider  first  the  relations  between  mutual  or  reciprocal 
telegraphic  transfer  rates,  or  a  pair  of  rates  such  as  the 
rate  in  Paris  on  London  and  the  rate  in  London  on  Paris, 
or  again  the  rate  in  New  York  on  London  and  the  rate 
in  London  on  New  York.  It  being  assumed  that  the  es- 
sential conditions  precedent,  namely  uninterrupted  com- 
munication, legal  freedom  of  dealing  and  continuous  and 
active  markets,  are  realized,  the  effect  of  arbitrage  is  to 
force  the  pair  of  mutual  rates  to  a  position  of  parity. 
This  is  any  position  at  which  the  two  express  or  record 
the  same  value-ratio  between  the  two  national  currencies. 
Thus  if  according  to  New  York's  rate  for  cables  on  Lon- 
don, pounds  are  to  dollars  as  4.8620  to  1,  the  London  rate 
for  cables  on  New  York  will  be  in  a  position  of  parity 
when  it  records  this  identical  ratio.  English  quotations  on 
New  York  are  now  being  published  by  the  Economist  (of 
London,;  in  the  form  of  I  lie  number  of  dollars  of  exchange 
procurable  for  one  pound.     Thus  to  be  at  a  parity  with 


612  FOREIGN  EXCHANGE 

our  rate,  their  rate  must  be  identical  with  ours,  even  with 
respect  to  the  exact  figures  which  express  it,  and  must  in 
the  case  in  hand  be  4.8620.  But  London  quotations  on 
New  York  have  also  been  put  in  the  form  of  the  number 
of  pence  payable  for  one  dollar  of  exchange,  as  for  ex- 
ample say  4911  The  position  of  parity  for  a  rate  quoted 
in  this  manner  would  be  49.362  or  close  to  49%. 

If  the  rates  deviate  from  parity,  even  to  a  very  slight 
extent,  two-point  arbitrage  springs  into  action  and  forces 
them  to  parity  or  to  a  negligible  distance  from  parity.14 
It  should  be  understood  there  are  an  indefinite  number 
of  positions  of  parity.  The  following  extraordinary  pairs 
are  all  at  perfect  parity,  in  the  sense  of  the  term  as  used 
in  connection  with  arbitrage. 

New  York  on  London  London  on  New  York 

4.60     52.174  d. 

1.50     160.        d. 

7.00     31.286  d. 

45.20     5.309  d. 

4.8665     mint  par 49.317  d. 

The  first  four  rates  in  New  York  on  London  are  so  far 
away  from  the  mint  par  that  they  look,  as  one  might  say, 
unnatural.  Nevertheless  the  rates  of  $4.60  and  $7.00  were 
actually  reached  during  the  great  war.  In  ordinary  times 
the  pair  of  rates  will  be  confined  between  the  gold-points, 
but  it  is  not  in  the  least  arbitrage  that  acts  so  to  restrict 
them,  but  the  shipment  of  gold.  Arbitrage  as  an  economic 
force  is  satisfied,  so  to  say,  whenever  the  rates  reach  a 
position  of  parity,  whatever  be  the  tilt  of  the  pair. 

It  is  only  the  cable  rates  that  arbitrage  tends  to  bring 
to  an  absolute  parity.  London's  sight  rate  on  New  York 
Will  be  lower  (in  the  sense  of  cheaper)  than  London's 
cable  rate  on  New  York.     New  York's  sight  rate  on  Lon- 

i*  This  operation  is  explained  in  §  97. 


THE  THEORY  OF  EXCHANGE  RATES     613 

don  will  be  lower  than  its  cable  rate  on  London.  A  mo- 
ment's reflection,  or  work  with  a  pencil,  will  make  it  clear 
that  if  the  mutual  cable  rates  are  at  a  parity  the  mutual 
sight  rates  cannot  be. 

Next  to  be  considered  is  the  wider  problem  of  the  in- 
terrelation of  rates,  or  their  interrelations  in  three  or 
more  countries.  By  reason  of  arbitrage  again,  the  rates 
in  all  countries  are  bound  together  in  a  certain  curious 
manner,  with  the  result  that  in  some  respects  their  move- 
ments are  constrained  or  conditioned  while  in  other  re- 
spects left  free.  These  wider  effects  do  not  flow  from  the 
two-point  but  from  the  three-point  and  more  complex 
forms  of  arbitrage.  It  must  be  said  however,  that  two- 
point  and  three-point  arbitrage,  carried  out  wherever  the 
movements  of  rates  present  opportunities,  are  together 
competent  to  produce  all  the  effects  on  the  world's  rate- 
structure  that  it  lies  in  arbitrage  to  produce.  If  four- 
point  or  more  complex  operations  were  unknown  or  im- 
possible, arbitrage  would  be  lacking  nothing  as  an  economic 
force. 

Let  us  now  take  the  case  of  three  cities  each  of  which  is 
assumed  to  deal  in  telegraphic  transfers  on  the  other  two. 
London,  Paris  and  New  York  will  serve,  though  we  know 
London's  market  in  exchange  on  the  other  two  capitals 
is  not  as  active  as  their  markets  for  sterling.  Three  na- 
tional currencies  are  involved  in  the  problem.  There  are 
likewise  three  value-ratios  between  currencies  and  three 
only.     These  ratios  are  those 

(1)  between  francs  and  pounds 

(2)  between  dollars  and  pounds 

(3)  between  dollars  and  francs 

Two-point  arbitrage  is  sufficient  to  make  each  pair  of 
mutual  rates  agree  as  to  the  value-ratio  to  which  they  per- 
tain.    If  the  London  cable  rate  on  New  York  makes  £1  = 


(ill  FOREIGN  EXCHANGE 

$4.86,  to  be  at  parity  the  New  York  cable  rate  would  have 
to  make  the  ratio  just  the  same.  Also  the  mutual  tele- 
graphic transfer  rates  between  London  and  Paris  would 
have  to  agree  on  some  figure,  let  us  say  £1  =  25.20  francs. 
With  these  two  ratios  determined  there  is  only  one  posi- 
tion left  for  the  ratio  between  New  York  and  Paris, 
namely  $1  =  5.185+  francs.  For  if  £1  =  $4.86  and 
£1  =  25.20  francs,  $4.86  ought  to  equal  25.20  francs,  which 
would  mean  that  $1  would  equal  5.185  -|-  francs.  But  so 
far  as  mere  two-point  arbitrage  goes,  the  New  York  and 
Paris  mutual  rates  might  agree  on  a  ratio  of  $1  =  4  francs 
or  any  other  ratio.  When  it  is  said  that  $1  "ought  to" 
equal  5  francs,  the  meaning  is  that  if  the  other  two  ratios 
maintain  themselves  as  given,  buying  and  selling  of  ex- 
change would  force  the  New  York  and  Paris  mutual  cable 
rates  to  the  ratio  of  $1  =  5.185  francs.  It  is  not,  however, 
two-point  but  only  three-point  arbitrage  that  is  capable 
of  forcing  this  result.  Why  it  should  necessarily  act  in 
this  manner  should  be  clear  in  view  of  the  explanations 
that  have  already  been  offered  in  Chapter  XIV  and 
especially  in  §  99.  In  the  problem  of  three  currencies 
any  two  of  the  value-ratios  imply  the  third,  just  as  the 
first  two  given  above,  namely, 

£1  =  $4.86 
and  £1  =  25.20  francs 
imply  £1  =    5.185  francs 

Now  whenever  the  third  ratio  is,  as  actually  recorded 
in  the  exchanges,  the  one  required  by  the  other  two,  we 
may  speak  of  it  as  being  consonant  with  them.  When 
this  position  is  attained,  any  two  value-ratios  may  be  taken 
first  and  the  remaining  one,  as  third,  will  be  consonant 
with  them,  so  that  all  three  are  consonant.  There  are  an 
indefinite  number  of  positions  of  consonance.  For  example 
the  following  is  one : 


THE  THEORY  OF  EXCHANGE  RATES     615 

£1  =  50  francs 
£1=  2  dollars 
$1  =  25  francs 

The  fact  that  these  ratios  are  very  much  further  away 
from  the  mint  pars  than  any  known  to  actual  experience 
even  in  the  great  war,  does  not  mean  that  they  are  not 
perfectly  consonant.  Once  established,  there  would  be 
nothing  in  arbitrage  to  change  them.  The  influence  which 
would  prevent  their  establishment  is  not  arbitrage. 

To  summarize :  it  appears  that  in  any  three  countries, 
having  active  exchange  dealings  with  one  another,  arbitrage 
tends  ever  to  produce  a  certain  condition  of  equilibrium 
among  rates.  Complete  parity  is  producible  only  among 
the  rates  for  telegraphic  transfers. 

I.  The  condition  of  perfect  equilibrium  among  cable 
rates  in  the  triangle  of  the  three  countries,  A,  B,  and  C, 
involves 

1.  the  parity  of  each  mutual  pair  of  rates, 

2.  the  parity  of  either  rate  between  any  two  of  the 
countries,  as  A  and  B,  with  the  opposite  pair  con- 
sisting of  (1)  either  rate  between  C  and  A,  coupled 
with  (2)  either  rate  between  C  and  B,1"'  and  finally 
as  a  consequence, 

3.  the  perfect  consonance  of  the  three  exchange-ratios 
between   the  three   currencies. 

is  For  example,  the  N.  Y.  rate  on  London  will  be  at  a  parity  with 
the  following  four  pairs: 

(1)  N.  Y.  on  Paris — Paris  on  London, 

(2)  X.  Y.  on    Paris — London  on  Paris, 

(3)  Paris  on  N.  Y. — Paris  on    London, 

(4)  Paris  on  N.  Y. — London   on    Paris. 

Taking  number  (3)  from  among  these  at  random:  if  Paris  on 
N.  Y.  is  at  5.17%  francs  per  dollar,  and  Paris  on  London  is  at  25. 10 
francs  per  pound,  the  N.  Y.  rate  on  London  is  at   parity  if  it  stands 

at    4.85024+     (nearest   standard   quotation,    4.8500).     If    this    rate 


616  FOREIGN  EXCHANGE 

II.  There  are  an  indefinite  number  of  positions  of  per- 
fect   equilibrium  or  perfect  consonance  of  value  ratios.16 

III.  Except  for  cases  of  complete  or  partial  failure  of 
arbitrage  by  reason  of  inactivity  of  markets  for  certain 
classes  of  exchange  and  inadequacy  of  communications, 
triangles  of  countries  such  as  the  one  just  considered  would 
form  themselves  to  connect  each  single  country  in  the 
world  with  every  other  possible  pair  of  countries.  An  ap- 
proximation to  this  result  is  obtained  in  actuality. 

If  we  suppose  there  are  four  countries  in  a  system, 
namely  A,  B,  C,  and  D,  and  suppose  that  after  the  rate 
structure  of  A,  B,  and  C  has  reached  the  position  of  con- 
sonance of  value-ratios,  D  is  added,  and  its  rates  with  B 
and  C  form  another  perfect  triangle,  then  the  rates  of 
the  whole  four  as  a  system  will  have  reached  the  position 
of  consonance,  without  further  adjustments,  and  the  rates 
for  any  three  out  of  the  four  will  be  in  the  position  of 
consonance.  By  successive  additions  in  this  manner  of 
one  country  after  another  we  can  in  imagination  build  up 
the  rate  structure  for  the  principal  commercial  countries 
of  the  world. 

goes  appreciably  above  or  below  this  parity  an  arbitrage  operation 
becomes  possible.  For  one  example,  suppose  it  goes  to  4.8525,  the 
operation  will  be  to  sell  sterling  in  X.  Y.  This  requires  us  to  pro- 
duce a  fund,  or  create  a  credit,  in  London  by  way  of  Paris.  This 
can  be  done  under  the  "opposite  pairs"  of  rates  given  in  this  problem, 
by  selling  a  cable  on  N.  Y.  in  Paris  and  buying  a  telegraphic  transfer 
on  London  in  Paris.  This  will  produce  £1  in  London  at  the  cost  of 
$4.85024  -f-  (excluding  incidentals)  and  will  yield  a  gross  profit  of 
2yiooth  of  lc.  per  pound. 

is  The  sum  of  the  angles  of  a  triangle  equals  two  right-angles 
(except  in  non-Euclidean  geometry)  but  there  are  an  infinite  number 
of  shapes  of  triangles.  Arbitrage  imposes  certain  restrictions  upon 
the  configuration  of  the  rate  structure  of  three  countries,  but  there 
are  theoretically  an  infinite  number,  and  practically  an  indefinite 
number  of  positions  still  open  to  this  structure  even  under  these  re- 
strictions. 


THE  THEORY  OF  EXCHANGE  RATES     617 

If,  in  conclusion,  we  examine  the  significance  which  the 
interrelation  of  rates  due  to  arbitrage  has  for  the  foreign 
exchange  market  in  some  one  country,  we  find  that  the 
value  of  the  currency  unit  of  that  country  in  terms  of  the 
moneys  of  other  countries  is  free  to  rise  or  fall  to  any  ex- 
tent whatsoever.  That  is,  arbitrage  will  not  set  any  limits 
on  the  duration  or  extent  of  such  a  movement  as  a  whole. 
It  will  merely  impose  one  condition  upon  its  manifestation 
in  the  market  for  foreign  exchange.  As  the  value  of  the 
local  money  (in  terms  of  other  moneys)  rises,  the  local 
rates  for  exchange  on  other  countries  fall,  and  vice  versa. 
The  effect  of  arbitrage  is  merely  to  make  it  necessary  that 
the  separate  rates  on  all  the  other  different  countries 
should  fall  or  rise  in  just  the  same  proportion,  unless  their 
relative  values  change  meanwhile.  Thus  suppose  our  dol- 
lar appreciates  in  terms  of  sterling,  insomuch  as  the  rate 
for  sterling  in  New  York  falls  5%.17  Arbitrage  will 
necessitate  that  the  rate  on  Paris  should  also  fall ls  just 
5%,  unless  the  rates  of  exchange  between  England  and 
France  make  a  shift  meanwhile.  If  in  the  interim  sterling 
falls  perhaps  2%,  in  Paris,  then  arbitrage  will  determine 
just  how  far  francs  must  fall  in  New  York  19  to  keep  a 
position  of  parity  with  sterling  if  the  latter  falls  5%. 
Except,  then,  as  the  rates  of  exchange  between  foreign 
countries,  or  the  relative  value  of  the  currencies  of  these 
countries,  change  inter  se,  the  rates  of  exchange  in  our 
country  must  ascend  or  decline  together.  Often  of  course 
the  relations  among  foreign  currencies  change  quite  as 
much,  as  do  their  relations  with  our  currency,  and  it  is 

it  This  is  a  greater  movement  than  can  take  place  when  England 
maintains  the  gold  standard  with  the  gold  contents  of  the  pound 
unchanged. 

is  Fall,  in  the  sense  of  making  francs  cheaper.  As  the  rate  ia 
quoted,  the  actual  figures — francs  obtainable  per  dollar — would  rise. 

is  Virtually  but  not  precisely  3%. 


618  FOREIGN  EXCHANGE 

therefore  nothing  in  the  least  unusual  for  some  of  our 
exchange  rates  to  rise  while  others  at  the  same  time  are 
falling.  When  several  countries  maintain  the  gold  stand- 
ard, in  external  as  well  as  internal  relations,  and  keep  the 
weight  of  their  gold  money -units  unchanged,  the  fluctuation 
of  rates  among  these  countries  will  be  quite  closely  con- 
fined, not  in  the  least  through  the  influence  of  arbitrage 
but  through  that  of  gold  shipments.  The  fluctuations  of 
the  value  of  an  inconvertible  paper  currency  against  the 
background  of  the  other  moneys  of  the  world  generally, 
will  depend  in  part  on  the  course  of  the  values  of  these 
other  moneys  in  terms  of  commodities  and  in  part  on  the 
variations  of  the  value  of  the  inconvertible  paper  measured 
in  the  same  manner.  The  fate  of  the  money  at  home  de- 
pends of  course  on  the  policy  pursued  by  the  government 
issuing  it.  The  one  great  and  significant  principle  is  that 
the  greater  the  quantity  of  it  kept  in  circulation,  the  less 
its  purchasing  power  over  goods  tends  to  be.  Increase  its 
quantity  enough  and  its  purchasing  power  fades  towards 
the  vanishing  point.  Arbitrage  is,  of  course,  possible  in 
a  country  with  inconvertible  paper  money. 

§  157.  The  international  distribution  of  gold. — (A  century 
ago  the  economist  Kicardo  laid  down  the  doctrine  that  gold 
money  tends  to  distribute  itself  among  the  different  coun- 
tries of  the  world  in  such  proportions  as  to  attain  every- 
where an  equality  of  value-in-exchange  or  purchasing 
power  over  commodities.  Silver  money,  in  those  days  a 
standard  money  in  many  parts  of  the  world,  was,  of  course, 
conceived  to  come  under  the  same  rule."\  Each  country 
was  thought  of  as  having  a  natural  share  of  the  world's 
specie,  a  sort  of  national  quota,  to  which  its  actual  stock 
ever  tended  to  conform.  If  the  latter  should,  through  ex- 
cessive imports  of  goods  and  exports  of  specie  in  payment 
therefor,  be  brought  below  the  national  quota,  specie  would 
(owing  to  its  very  scarcity  in  the  country)  ascend  in  value 


THE  THEORY  OF  EXCHANGE  RaTES     619 

or  gain  in  purchasing  power  over  goods,  or,  what  is  the 
same  thing,  prices  of  goods  or  their  values  in  terms  of 
specie  would  fall.  This  fall  of  prices,  making  the  country 
a  good  market  in  which  to  buy,  would  operate  to  increase 
its  exports  of  goods,  and,  making  it  a  poor  place  to  sell, 
would  tend  to  decrease  its  imports,  until  the  change  in 
the  relation  of  these  two,  constituting  a  reversal  in  the 
balance  of  trade,  would  restore  the  national  stock  of 
money  by  causing  specie  to  flow  back  again.  Excessive 
imports  of  specie  (i.e.,  those  making  the  actual  stock  rise 
above  the  natural  share)  would  correct  themselves  by  pro- 
ducing just  the  opposite  effects  on  the  balance  of  trade. 

Since  Ricardo's  day  the  world  has  given  much  thought 
to  the  methods  of  measuring  the  general  purchasing  power 
of  money  over  goods,  that  is,  to  the  problems  of  index 
numbers,  and  has  come  to  regard  the  subject  as  not  with- 
out its  difficulties.  (  Since  Ricardo's  day  the  banking  and 
credit  systems  of  the  nations  have  grown  enormously  in 
size  and  complexity,  the  machinery  for  international  short- 
term  borrowing  and  lending  has  been  much  developed,  and 
discount  rates  and  prices  of  gold  have  come  to  be  mani- 
pulated with  a  view  to  the  regulation  of  the  gold  move- 
ment. Thus  under  modern  conditions  the  fundamental 
forces  affirmed  in  Ricardo's  theory  are  covered  over  and 
obscured  by  such  a  number  of  proximate  causes  affecting 
the  How  of  gold  that  the  truth  of  the  theory  is  not  always 
clearly  perceived.  ^ 

^The  conception  is  that  the  geographical  distribution  of 
gold  money  reaches  a  condition  of  equilibrium  when  this 
money  has  attained  equal  commodity  values  in  the  differenl 
parts  or  countries  of  the  worlds  (Until  we  can  agree  upon 
some  method  of  measurement  whereby  we  shall  be  able  to 
determine  in  fact  whether  or  not  gold  has  precisely  the 
same  general  purchasing  power  in  one  country  as  in  an- 
other, we  had  better  restrict  our  claim  to  the  proposition 


620  FOREIGN  EXCHANGE 

that  gold  seeks  to  distribute  itself  in  such  proportions  as 
to  arrive  at  a  rough  equality  of  general  purchasing  power 
in  different  countries.20^  It  is  believed  then  that  any  gross 
inequality  in  value  as  thus  defined,  any  inequality  so  great 
as  to  be  indisputable  despite  the  problem  of  the  measure- 
ment of  fine  differences,  will  tend  to  correct  itself,  it  being 
assumed  of  course  that  governments  permit  the  free  move- 
ment of  the  metal  (an  assumption  which  did  not  hold  dur- 
ing the  period  of  the  great  war).21 

It  is  safe  to  assert  that  Kicardo's  theory — as  a  theory 
of  the  fundamental  or  underlying  factors  governing  gold 
movements — is  acceptable  to  the  great  majority  of  political 
economists  to-day.  It  has  been  attacked  by  some  who  dis- 
believe in  the  so-called  "quantity  theory"  of  the  value 
of  money,  even  in  the  mild  form  in  which  this  doctrine  is 
implied  in  Ricardo's  theory.  It  will  not  be  the  attempt 
here  to  argue  the  case  exhaustively,  as  this  would  involve 
a  very  lengthy  discussion  and  force  this  book  beyond  the 
confines  expediency  has  set  upon  it.  But  let  us  give  the 
matter  a  little  more  consideration. 

Suppose,  owing  to  technical  business  developments  Eng- 
land begins  to  sell  us  so  much  merchandise  and  we  come 
to  sell  England  so  little,  that  (whatever  be  the  national 
credits  and  debits  arising  from  interest,  insurance,  and 
shipping  charges  and  the  like)  a  chronic  condition  of  great 
demand  and  slight  supply  of  sterling  exchange  arises  in 
our  market.  The  exchange  rate  on  England  stays  per- 
sistently at  the  gold-export  point.  Steadily  and  in  large 
volume  the  metal  flows  from  us  to  England.  The  first 
effects  will   probably  be  rising  money   rates  here   and   a 

20  As  a  matter  of  theory  it  would  seem  that  it  seeks  to  equalize 
its  general  purchasing  power,  not  over  all  commodities  in  the  several 
countries,  but  only  over  those  as  a  group,  that  are  capable  of  export 
and  import  between  countries. 

21  The  effects  of  foreign  trade  tariffs  are  not  taken  into  account 
in  this  brief  statement. 


THE  THEORY  OF  EXCHANGE  RATES     621 

falling  away  of  them  in  England.  This  will  tend  tQ< 
remedy  the  difficulty.  It  will  probably  lead  to  our  draw- 
ing finance  bills  which  will  immediately  add  to  the  supply 
of  demand  sterling  exchange  in  our  market  in  the  manner 
already  explained  in  Chapter  XII.  English  banking 
houses  will  be  inclined  to  place  short-term  loans  with  us, 
in  order  to  gain  the  higher  interest  procurable  here.  This 
will  also  mean  a  supply  of  demand  sterling  at  the  time 
of  the  making  of  the  loans.  Our  stiff  money  rates  will 
tend  to  lower  the  prices  of  interest-bearing  securities  in 
our  market,  while  the  reverse  conditions  will  tend  to  raise 
them  in  England,  so  that  in  consequence  we  may  sell  quan- 
tities of  them  to  England,  and  against  all  such  sales  sterling 
exchange  will  be  drawn  and  sold  in  this  country. 

Perhaps  all  this  will  break  the  exchange  market  and 
pull  the  sterling  rate  away  from  the  gold-export  point. 
Perhaps  the  rate  will  be  driven  even  to  the  import  point 
so  that  we  shall  begin  to  recover  specie.  But  suppose — 
merely  suppose — the  perverse  tendencies  in  our  merchan- 
dise commerce  remain  unabated.  If  we  keep  on  buying 
foreign  goods  in  sufficient  excess,  the  system  of  holding 
our  gold  by  borrowing  abroad  and  selling  bonds  and  stocks 
will  in  time  reach  the  point  of  exhaustion.  What  then? 
Is  there  some  fundamental  remedy  which  will  go  to  the 
seat  of  the  trouble?  Assuredly.  As  the  quantity  of 
money  and  credit  in  the  country  undergoes  further  and 
further  contraction,  the  prices  of  goods  must  begin  to  drop, 
if  not  absolutely,  at  least  relatively  to  prices  in  England. 
The  plethora  of  money  and  credit  in  England  will  tend 
to  raise  prices  there.  The  consequence  will  be  that  many 
things  formerly  importable  from  England  will  cease  to  be 
import  able,  by  reason  of  increased  dearness  there  and  in- 
creased cheapness  here,  and  many  things  not  exported  by 
us  before  will  become  exportable  for  precisely  the  same 
reason.     Thus  if  the  preliminary  remedies  fail,  the  later 


622  FOREIGN  EXCHANGE 

and  more  fundamental  one  is  bound  to  be  generated.  Let 
exports  of  specie  be  supposed  to  go  far  enough,  and  no 
fair-minded  and  informed  thinker  can  deny  the  inevitable- 
ness  of  the  events  that  have  been  pictured.  The  funda- 
mental natural  remedy  is,  or  at  least  may  become,  pretty 
drastic.22  As  stated  on  an  earlier  page,  its  existence  is 
no  reason  for  failing  to  employ  consciously  and  under 
central  banking  management,  the  less  severe  "artificial" 
remedies.23  If  we  admit  the  existence  of  this  fundamental 
"natural"  remedy,  we  admit  the  essential  point  in  the 
Ricardian  theory  of  the  international  distribution  of  specie. 
We  speak  of  "excessive"  exports  or  imports  of  gold, 
meaning,  of  course,  such  movements  as  will  make  a  coun- 
try's stock  of  the  metal  either  excessively  small  or  exces- 
sively great.  (  The  "natural"  share  of  gold  belonging  to 
the  country,  as  conceived  by  Ricardo,  is  the  amount  which 
is  neither  too  great  nor  too  small  in  comparison  with  the 
amounts  held  by  the  rest  of  the  world.  This,  the  national 
quota,  is  the  quantity  which  will  make  the  general  price 
level  of  the  group  of  internationally  movable  commodities 
the  same  here  as  abroad.)  Each  gold  standard  country 
will  have  its  quota  when  the  general  price  level  of  this 
group  of  commodities  is  equalized  in  all  the  countries.24 
k  Making  a  summary  statement  without  proofs,  it  may  be 
said  a  given  country's  quota  or  share  of  specie  is  a  greater 
one,  the  greater  its  volume  of  trade,  and  a  lesser  one  the 

22  By  reason  of  leading  to  a  slowing  down  of  industry  and  inducing 
"hard  times." 

23  Compare  §§   143-147. 

24  The  function  of  commerce  is  constantly  to  move  goods  from 
where  they  are  most  readily  produced  and  cheap  to  the  places  where 
they  are  dear.  If  commerce  performed  this  function  with  perfect 
continuity  and  smoothness  the  various  national  stocks  of  money 
might  maintain  themselves  in  a  continuous  state  of  equilibrium. 
But  there  is  too  much  that  is  new  arising  in  commerce  all  the  tims 
for  this  condition  to  be  realized. 


THE  THEORY  OF  EXCHANGE  RATES     623 

greater  the  extent  to  which  it  uses  substitutes  for  gold  as 
a  means  of  payment  such  as  other  forms  of  money — gov- 
ernment and  bank  notes — and  checks  on  deposits  with 
banks.  The  greater  the  rapidity  of  circulation  of  gold 
money,  other  forms  of  money,  and  bank  deposit  "cur- 
rency," the  less  the  national  quota.25   ) 

In  view  of  the  gigantic  superstructure  of  credit  reared 
in  more  modern  times  upon  the  foundation  of  gold — which 
has  so  often  been  likened  to  an  inverted  pyramid — we 
should  in  conclusion  state  quite  explicitly  the  reservations 
that  ought  to  be  made  as  to  the  adequacy  of  the  so-called 
"natural"  remedy  for  gold  drains.  The  operation  of  this 
remedy  is  always  dependent  upon  the  maintenance  of  the 
gold  standard.  It  is  this  which  will  necessitate  a  contrac- 
tion of  credit  as  gold  drains  take  place,  and  thus  bring 
into  operation  the  corrective  of  falling  (or  relatively  fall- 
ing) prices  of  goods  and  commodities.  For  any  untoward 
development  of  commerce,  leading  to  a  chronic  excess  of 
imports,  a  development  which  by  reason  of  its  very  na- 
ture would  have  to  come  somewhat  gradually,  the  "nat- 
ural" remedy  is  not  only  adequate  but  is  the  only  real 
cure.  This,  however,  does  not  signify  that  it  is  all-suffi- 
cient, and  that  the  practices  of  European  central  banks 
in  supplementing,  or  better,  in  anticipating  it  are  works 
of  supererogation.  Measures  must  be  taken  to  meet  gold 
drains,  which  under  the  somewhat  hectic  conditions  of 
modern  credit  may  inflict  themselves  on  a  country  as  a 
"run"  inflicts  itself  on  a  bank.  In  fact,  the  tendency 
of  the  times  is  to  concentrate  a  country's  gold  in  its  cen- 
tral bank,  and  a  foreign  drain  of  sufficient  proportions 
(like  that  of  11)07  from  England)  is  virtually  nothing  but 
a  great  run  on  this  central  bank. 

25  Further  explanations  would  lead  into  the  theory  of  the  purchas 
in<;  power  of  money.  The  besl  work  on  this  Bubject  is  [rving  Fisher's 
"Purchasing  Power  of  Money,*'  Macmillan  &  Company,  New  York. 


ADDENDUM 
THE  QUESTION  OF  DOLLAR  EXCHANGE 

In  recent  times  attention  has  been  attracted  to  the 
question  of  dollar  exchange,  or  the  question  as  to  the  fu- 
ture of  the  draft  drawn  payable  in  dollars,  as  an  instru- 
ment of  international  trade.  Bills  of  exchange  employed 
in  internal  trade,  being  always  of  course  drawn  in  dollars, 
might  be  included  under  "dollar  exchange"  in  a  broad 
sense,  but  the  question  being  mooted  to-day  does  not  con- 
cern domestic  paper.  However,  both  bills  drawn  for  the 
acceptance  of  bankers'  and  merchants'  bills  on  merchants 
are  coming  into  greater  use  in  the  home  trade,  and  this 
tends  to  further  a  like  development  in  our  foreign  com- 
merce by  making  for  an  acquaintanceship  with  accept- 
ances and  by  aiding  in  the  building  up  of  a  broad  and  ac- 
tive discount  market  for  such  instruments. 

The  importance  of  dollar  exchange  in  foreign  trade  has 
indeed  grown  considerably  during  the  latter  years  of  the 
war,  but  what  many  hope  for  is  that  it  may  come  to  hold 
something  of  the  position  that  sterling  exchange  has  had. 
Whether  or  not  we  care  to  make  predictions  in  this  field, 
we  can  set  forth  what  the  realization  of  this  expectation 
would  signify.  In  the  first  place,  dollar  exchange  might 
come  to  fulfill  the  same  functions  in  our  own  foreign  com- 
merce that  sterling  exchange  has  fulfilled  in  the  foreign 
commerce  of  the  United  Kingdom.  But  in  the  second  place, 
and  beyond  this,  it  might  come  to  function  in  commerce 
which  does  not  touch  our  shores  but  which  goes  direct 
between  two  foreign  countries,  in  the  way  sterling  exchange 

624 


ADDENDUM  625 

has  for  years  functioned  for  commerce  not  entering  the 
United  Kingdom.1 

If  dollar  exchange  comes  to  occupy  the  field  in  connec- 
tion with  our  own  foreign  commerce  it  would  mean  that 
some  of  the  exporters  who  ship  to  the  United  States  would 
draw  long  bills  on  our  importers,  payable  here  and  in  dol- 
lars. For  these  "trade"  bills  there  would  have  to  be  a 
market  in  the  exporters'  countries.  In  this  country  they 
would  be  discountable  after  acceptance,  except  possibly 
documentary  payment  bills.  Documentary  instructions 
would  sometimes  run  "documents  for  acceptance,"  some- 
times "documents  for  payment."  We  should  have  an 
open  or  public  ' '  retirement  rate  of  discount. ' ' 2  Our  banks 
might  or  might  not  develop  a  custom  of  discounting  docu- 
mentary payment  bills.  If  an  exporter  to  this  country 
demanded  a  bank  credit,  he  would,  under  the  conditions 
we  are  discussing,  be  willing  to  take  a  credit  established 
by  our  importer  with  an  American  bank,  instead  of  as 
formerly  one  with  a  London  bank,  established  through  the 
intermediation  of  an  American  bank.3  His  dollar  draft 
on  our  bank  would  have  to  be  readily  salable  in  the  country 
of  export,  and  would  be  discountable  here  as  a  banker's 
acceptance. 

Coming  to  the  draft  of  our  exporter  on  his  foreign  buyer, 
unless  he  drew  in  a  sum  of  the  money  of  the  foreign 
country  itself  (which  would  be  uncommon),  he  would  draw 
for  a  return  draft  on  New  York  in  dollars.  With  the 
system  fully  developed  this  might  be  one  at  60  or  90  days' 
sight  as  well  as  one  payable  on  demand.4  And  if  our 
exporter  demanded  a  bank  credit  what  he  would  be  offered 

i  Compare  §  39  for  an  illustration. 

2  Compare  §  35. 

3  Compare  §§  37,  38,  and  39. 

*  On  certain  countries  we  have  been  drawing  for  return  demand 
drafts  on  New  York  for  some  time  hack. 


626  FOREIGN  EXCHANGE 

and  would  take  would  be  one  with  an  American  bank, 
authorizing  him  to  draw  upon  it  a  bill  (usually  a  term 
bill)  in  dollars.  This  credit  would  be  established  by  the 
foreign  importer  through  the  intermediation  of  some  bank- 
in  his  country,  possibly  an  American  branch,  or  a  bank 
managed  by  American  capital. 

If  these  conditions  are  realized  dollar  exchange  replaces 
sterling  in  the  field  of  our  own  foreign  commerce.  But 
going  further,  if  it  is  to  play  the  role  in  the  world  at  large 
which  has  fallen  usually  to  sterling,  it  will  come  to  pass 
that  the  importer  in  some  foreign  country  A  will  provide 
the  exporter  in  some  other  foreign  country  B  with  a  dollar 
credit  at  a  New  York  bank,  and  settlement  will  proceed 
on  exactly  the  same  lines  as  those  described  in  Chapter 
VII  of  this  book,  New  York  being  substituted  for  London 
and  dollars  for  pounds. 

Now,  as  for  predictions,  New  York  will  probably  not 
displace  London  for  years  and  years  to  come.  Our  re- 
sources, actual  and  potential,  are  greater  than  those  of  the 
United  Kingdom,  our  foreign  trade  will  probably  grow 
to  huge  proportions,  but  New  York  will  not  soon  displace 
London,  The  British  have  a  tremendous  going  concern 
in  this  business  of  banking  for  foreign  trade.  New  York 
may  come  to  share  the  business  with  London,  taking  a 
place  similar  to  London's  with  respect  to  some  foreign 
countries,  perhaps  in  Latin  America  and  the  near  Orient. 
But  the  one  great  factor  upon  which  the  development  of 
New  York  as  a  foreign  trade  financing  center  depends 
is  the  maintenance  there  of  a  discount  market  capable  of 
absorbing  (that  is,  buying)  the  great  volume  of  bills  im- 
plied in  this  development,  AT  DISCOUNT  RATES 
WHICH  WILL  AVERAGE  AS  LOW  AS  THOSE  OF 
THE  OTHER  CENTER  PREPARED  TO  OFFER  SUCH 
A  SERVICE,  NAMELY,  LONDON.  Otherwise  the  ad- 
vantage will  remain  with  the  sterling  long  bill,  because 


ADDENDUM  627 

exporters  will  get  more  out  of  these  bills  for  their  ship- 
ments in  the  long  run.  The  quotation  beneath,  from  the 
Federal  Reserve  Bulletin  for  January,  1918,  pages  21  and 
22,  offered  by  way  of  conclusion,  speaks  for  itself. 

BANKERS'  ACCEPTANCES  IN  LONDON  AND  NEW 
YORK 

The  following  computation  prepared  by  Mr.  Leopold  Fredrick, 
of  the  American  Smelting  &  Refining  Co.,  furnishes  data  con- 
cerning the  estimated  amount  of  acceptances  outstanding  in 
London  and  New  York  at  a  date  approximate  the  end  of 
November : 

London 

Acceptances  of  all  London  clearing-house  banks, 
colonial  banks,  foreign  agencies,  and  private  bank- 
ers outstanding  in  the  neighborhood  of $500,000,000 

New  York 

Acceptances  of  New  York  national  and  State  banks 

and  trust  companies   270,000,000 

Acceptances  of  foreign  trade  corporations  and  for- 
eign agencies  established  in  New  York 55,000,000 

Acceptances  of  private  bankers  40,000,000 

Total     $365,000,000 

Deduct  acceptances  issued  for  the  purpose  of  financ- 
ing domestic  trade 155,000,000 

Total  of  acceptances  representing  the  financ- 
ing of  imports  and  exports  through  New 
York     $210,000,000 

In  commenting  upon  these  figures  Mr.  Frederick  says : 

"The  foregoing  figures  show  that  London  is  far  ahead, 

and  I  believe  that  even  with  the  much-needed  improvement 

of  the  machinery  for  financing  international  trade  London 

will  still,  for  many  years  to  come,  outdistance  New  York. 


628  F0KK1CN  EXCHANGE 

We  are  lacking  here  the  large  number  of  merehants- 
bankers'  old-established  accepting  houses  with  business 
ramifications  all  over  the  globe.  "We  here  will  be  satisfied 
if  we  can  hold  the  Central  and  South  American  and  Far 
Eastern  business.  Although  dollar  exchange  has  made 
great  strides  since  the  war,  the  New  York  discount  market 
is-  still  in  its  infancy.  For  the  present  there  is  little 
likelihood  that  we  will  get,  except  occasionally,  the  financing 
of  the  continental  trade  of  Europe.  It  is  hardly  likely 
that,  say,  an  Amsterdam  merchant  importing  goods  from 
France  will  seek  accommodation  in  New  York ;  he  will  go 
as  heretofore  to  London.  It  may  be  possible,  I  think,  that 
this  handicap  of  location  will  be  partly  overcome  in  the 
future  with  the  aeroplane  development,  which  would  nar- 
row down  the  time  consumed  by  the  mail  in  transit." 


THE  END 


SUBJECT  INDEX 


(See  Index  of  authorities   on  page  647) 


Abrasion  of  coin,  in  relation  to 
the  price  of  gold,  449. 
See   also,   Tolerance. 

Acceptance,  15-7,  conditional, 
109,  114-16;  presentment 
for,  31-2;  same,  withheld 
for  inspection  of  goods, 
333^4. 

Acceptance,  bank;  bank  grant- 
ing, not  a  true  lender  of 
money,  363-4;  as  a  loan 
of  credit,  371;  compensa- 
tion for,  commission  and 
not  interest,  324;  profit 
for,  instead  of  commission, 
in  case  of  dollar  loan  by 
foreign  bank,  362-3. 

Acceptance,  banker's,  against 
exporter's  bill,  321-5 ; 
illustration  of  same,  323-4. 

Acceptance  account,  144  et  seq. 

Acceptances  houses,  London, 
208. 

Acceptances;  in  English  bank 
statement,  212,  215-6;  for 
whom  granted,  216;  in 
New  York  and  London 
compared,  627. 

Advance,  burden  of,  in  case 
of  dollar  loan,  363-4. 

Advances  against  collection,  99, 
321-5. 

Advances,  interest-free,  by  Eu- 
ropean banks  to  facilitate 
gold   import,    571-3. 

62f) 


Allonge,  26. 

Alloy,  440-1. 

American  Bankers'  Association, 
traveler's   cheque,   187. 

Arbitrage  of  exchange,  397  et 
seq.;  preliminary  illustra- 
tion of,  397-9 ;  formal  def- 
inition of,  399;  distin- 
guished from  certain  other 
technical  operations,  423; 
as  a  computation,  400-1; 
two-point,  408-16 ;  same, 
cases  of,  409;  three-point 
and  more  complex,  418-23 ; 
sixteen  fundamental  cases 
of  three-point  arbitrage, 
419-20;  four-point,  421-2; 
for  future  delivery,  424-5; 
pure,  without  speculation, 
423 ;  rapid  work  in,  425-6. 

Arbitrage  and  rates;  general 
theory  of  interrelation  of 
rates,  611-18;  parity  of 
pair  of  mutual  rates,  611- 
13;  rates  in  three  countries, 
general  theory,  613-16 ; 
world's  exchange  rate 
structure,  616-18. 

Arbitrage  in  stocks,  426  et  xcq.; 
same,  illustrated,  427-8. 

Arbitrated  parities,  397-404; 
same  and  direct  and  indi- 
rect methods  of  rate  quota- 
tion,   108n. 

A  ihil  rated  par  of  exchange,  dis- 


030 


SUBJECT  INDEX 


tinguisbed  from  mint  par, 

401-2;   use  of,  illustrated, 

403-4. 
Arbitrated  prices,  397—404. 
Arbitrated   rates,  397-404. 
Arbitrager,  arbitrageur,  399. 
Arbitration   of  excbange.     See 

Arbitrage. 
Arrival  discount  rate,  255. 
Assignment    of    book-accounts, 

161n. 
'Authority    to    purchase,"    171 

et    seq.;    contrasted    with 

bank  credit,  171. 
Australasia;      bills     on,     with 

"colonial      clause,"      310; 

London  rates  on,  312. 

Balance;  the  foreign,  190;  in- 
terest-free, 204;  dealing  in 
bills  on  places  -where  no 
balance  is  kept,  337-42. 
See  Deposit. 

Bank  credit,  131  et  seq.;  as 
means  of  financing  a  ship- 
ment, 160 ;  confirmed 
credit,  169;  and  terms 
"cash  against  documents," 
332. 
See  also  Commercial  credit. 

Bank  discount,  53. 

Bank  of  England,  231  et  seq.; 
specimen  statements  of, 
235-6 ;  issue  department 
and  notes,  232-3. 
See  also  Bank  rate  and 
Bank  price  of  gold. 

Bank  of  England  discount  rate, 
237  et  seq.;  bank's  dis- 
count policy,  240  et  seq.; 
character  of  rediscount 
business,  242;  "bill  brokers 


in  the  bank,"  246;  redis- 
counting  at,  244;  reserve 
and  discount  rate,  247; 
rate  to  Clearing  Banks, 
243;  bank  rate  and  open 
market  rates,  252;  manipu- 
lation of  bank  rate  to  in- 
fluence gold  movement, 
546-56;  making  bank  rate 
effective,  546-7. 

Bank  of  England  note,  492-4; 
resemblance  to  gold-certifi- 
cate, 233,  493^. 

Bank  of  England's  price  for 
gold,  504;  terms  of  pur- 
chase of  gold,  504-5;  sys- 
tem of  manipulation  of,  to 
influence  gold  movement, 
558-60. 

Bank  of  England,  cash  at,  of 
other  banks,  214. 

Bank  of  England,  special  war- 
time credits,  249-50. 

Bank  of  England,  relation  of, 
with  Federal  Reserve  Bank 
of  New  York,  243-4. 

Bank  of  France;  price  of  gold 
at,  509-13;  terms  on  which 
buys  gold,  512-3;  gold- 
premium  policy  of,  563- 
71;  extent  of  employment 
of  latter,  566-7;  excep- 
tional stability  of  discount 
rate  of,  569-70. 

Bank  price  of  gold,  in  England, 
502-7;  in  France,  509-13; 
in  Germany,  513-16. 

Bank  rate;    in   England,   237- 
50;  in  France,  exceptional 
stability  of,  569-70. 
See  Bank  of  England  dis- 
count rate. 


SUBJECT  INDEX 


631 


Bankers'  acceptances.  See  Ac- 
ceptances. 

Banking,  meaning  of,  56. 

Bill  of  exchange,  11  et  seq.; 
legal  definition  of,  11-12; 
parties  to,  13;  usually  non- 
interest  bearing  contract, 
43;  uses  of,  13-4;  use  of, 
in  settlement  illustrated, 
69  et  seq.;  settlement  with- 
out bill  by  exporter,  318- 
21. 

Bills  taken  by  bankers;  bankers' 
buying  rates  for  bills,  256 
et  seq.;  outright  purchase 
and  receipt  for  collection, 
321-2. 

Bills  discounted,  as  asset  of 
London  bank,  214-15. 

Bills  in  sets,  101-2. 

Bills  on  South  America,  instruc- 
tions for  drawing,  304-6. 

Bills  of  a  more  technical  char- 
acter; drawn  on  foreign 
country  in  home  money, 
275  et  seq.;  same,  banker's 
buying  rate  for,  282  et 
seq.;  same,  manner  of  dis- 
charge of,  277-9;  same, 
computing  amount  drawn 
for,  276-7;  bills  on  a  for- 
eign country  in  money  of  a 
third  country,  284  et  seq.; 
same,  settlement  involving 
three  currencies,  286;  same, 
method  of  settlement  with, 
287;  same,  the  risks  of  ex- 
change, 288;  same,  deter- 
mining the  amount  drawn 
for,  280  et  seq.;  same,  use 
of  explained,  202-3;  same, 
outcome  to  the  purchasing 


banker,  293-5;  same,  spe- 
cial agreements  covering 
risk  of  exchange,  295-6; 
same,  taken  under  a  dis- 
count rate,  297-8;  the  bill 
with  an  interest  clause, 
306-10;  the  bill  with  the 
"colonial  clause,"  310-18. 

Bill-brokers  of  London,  218  et 
seq.;  profit  of,  illustrated, 
219-20;  guarantee  of  bills 
by,  220-1 ;  relation  to  great, 
banks,  221-2;  "in  the  Bank 
of  England,"  246. 

Bill  of  lading,  102  et  seq.; 
"order,"  103;  "straight," 
103;  "through,"  105;  as 
collateral,  legal  nature  of 
holders  interest,  154n; 
handling  of,  in  connection 
with  commercial  credit, 
138-9,  155-6. 

Bimetallic  standard,  definition 
of,  430. 

Bolivar,  of  Venezuela,  484. 

Book-accounts,  assignment  of, 
161n. 

Borrowing  by  means  of  ex- 
change, *  359-80,  343-7; 
distinguished  from  ordi- 
nary international  borrow- 
ing, 343-4,  359;  and  in- 
vestments in  exchange,  con- 
trasted, 344 ;  possible  with 
domestic  exchange,  359-60. 

Branch  banks,  American,  in 
London,  230. 

Brassage,  434. 

Brazilian  currency,  comment  on, 
280-1. 

Broker,  see  Bill-broker. 

Bullion,    see    Standard    bullion 


632 


SUBJECT  INDEX 


and  Standard  money,  and 
Mint  price. 

Bullion  value;  full,  of  standard 
coin,  456;  bullion  and 
nominal  values  of  token 
coin,  465-8;  coining  and 
market  value  of  token  bul- 
lions, 468-71. 

Buying  rates,  bankers',  for  bills, 
256  et  seq.;  for  banker's 
long  bill,  computed  by  the- 
oretically correct  method, 
260-1;  same,  by  practical 
method,  263;  error  in 
latter,  265;  for  merchants' 
bills  on  bankers,  266  et 
seq.;  for  documentary  ac- 
ceptance trade  bills,  267; 
for  documentary  payment 
bills,  a  special  problem, 
268-70,  391  et  seq.;  for 
bill  on  a  foreign  country  in 
home  money,  282  et  seq.; 
same,  in  money  of  a  third 
country,  293-5,  297-8;  for 
bills  bearing  the  "colonial 
clause,"   315. 

Cable,  as  form  of  exchange,  89. 

Cable  rate,  reason  for  height  of, 
90 ;  general  theory  of  cable 
spread,  601-11;  cable  rate 
not  basis  of  long  rate, 
273— 1 ;  certain  extraordi- 
nary' cable  spreads,  601-4. 

C.A.F.,  335-6. 

Call  loans  of  London  banks, 
214. 

Capital,  callable  and  reserved, 
of  London  joint-stock 
banks,  210. 

"Cash      against      documents," 


330-3;  settlement  under 
these  terms,  318-9;  and 
methods  of  settlement, 
327-8;  bank  credit  should 
niL'et  these  terms,  332. 

"Cash  with  order,"  329-30. 

Certificates,  gold  and  silver, 
465. 

Certified  invoice,  116-17. 

C.F.,  335-6. 

Check,  20;  traveler's,  181  et 
seq. 

C.I.F.,  335-6. 

Classification  of  exchange,  84 
et  seq. 

Clean  bills,  100,  270 ;  why  Lon- 
don discounts  clean  bills 
only,  270-1. 

Codes,  used  for  telegraphic 
transfers,  89. 

Coin,  prices  of  foreign,  and  the 
mint  par,  435-6. 

Coins ;  of  England,  492 ;  of  the 
United   States,  486-7. 

Coinage;  laws  of,  and  exchange 
rates,  429-42;  on  govern- 
ment and  private  account, 
439;  free  and  gratuitous, 
437-40. 

Coining  value;  and  market 
value  of  token  bullions, 
468-71;  of  gold  and  silver 
in  the  United  States,  his- 
tory of,  469n;  two  coining 
values  of  silver  in  the 
United  States,  470 ;  coining 
value  of  silver  in  different 
countries,  471. 

Collateral  security,  85-6 ; 
banker's  legal  interest  in 
merchandise  as,  152  et 
seq.;   plans  for  surrender 


SUBJECT  INDEX 


633 


of  goods  to  importer,  156 
et  seq. 

Collection  of  bills,  99,  322. 

Colonial  banks,  British, 
branches  in  London,  227 
et  seq. 

"Colonial  clause,"  310-18;  ef- 
fect to  make  bill  sell  at  rate 
for  sight  bill  on  London, 
315;  confusion  of  discount 
and  premium  in  connection 
with,  316;  not  common  in 
bills  drawn  in  England  on 
colonies,  317;  customary 
methods  of  handling  bills 
bearing,  317-18;  compared 
with  interest  clause,  318n. 

Commercial  credit,  131-89 ;  na- 
ture and  uses  of,  131-3; 
same,  illustrated,  136-40 ; 
specimen  letter  of  credit, 
136-7;  provisions  of  letter 
of  credit  analyzed,  137-8; 
handling  of  bills  of  lading 
under,  138-9,  155-6;  bank- 
ing operations  involved  in 
use  of,  141-7;  risk  of 
goods  under,  149-50;  revo- 
cation of,  150;  specimen 
contract  for  letter  of 
credit,  151-2;  as  means  of 
financing  a  shipment, 
160-3;  risk  of  exchange 
under,  164-66;  nature  of 
banker's  risk  under,  177; 
commissions  for,  179;  ad- 
vantages of,  summarized, 
167;  confirmed,  169. 

Commereial  letter  of  credit,  see 
Commercial  credit. 

"Commercial  on  banks,"  88. 

Commercial   paper,   1-21,  9   et 


seq.;  not  money,  5;  defini- 
tion, 10;  utility  of,  11;  im- 
portance of  negotiability 
of,  26. 

Commissions ;  for  commercial 
credits,  179  et  seq.;  same, 
contrasted  with  interest, 
180-1 ;  correspondents', 
205;  London  banks'  usual, 
206-7. 

Commission  houses,  activity  of 
illustrated,  332. 

Commodity  standard-money, 
456-8 ;  exportability  of, 
463-4. 

Conditional  acceptance,  109, 
114  et  seq. 

Confirmed  credit,  169. 

Consignee,  consignor,  consign- 
ment, 102. 

Consignee,  real,  notification  of, 
104. 

Consular  certificates  and  certi- 
fied invoices,  116-7. 

Continentals,  defined,  80. 

Copper,  charge  for,  in  standard 
bullion  in  United  States, 
441-2. 

"Correcting  the  exchanges," 
546. 

Correspondent  banks,  services 
and  compensation  of,  199 
et  seq. 

"Cotton  for  payment,"  88. 

Current  and  deposit  accounts, 
of  English  banks,  211-12. 

Dealers  in  exchange,  classes  of, 
63^. 

Defenses  against  payment  on 
negotiable  instruments,  24 
et  seq. 


634 


SUBJECT  INDEX 


Delegation,  318-21;  letter  of, 
320-1. 

Deposit  and  current  accounts  of 
English  banks,  211-12. 

Deposits   and  reserve,   57. 

Deposit  allowance  rate,  London, 
206;  and  bank  rate,  250-1. 

Discount,  39-55 ;  contrasted 
with  interest,  43;  reason 
for  existence  as  distinct 
from  interest,  51-2;  illus- 
trative problems,  45-51 ; 
usage  of  verb  "to  discount," 
52;  rediscount  defined,  52; 
bank  discount  and  true  dis- 
count, 53;  as  interest  in 
advance,  53-55. 

Discount  house,  53;  discount 
houses  of  London,  218  et 
seq.,  222;  margins  of  dis- 
count, 223;  specimen  bal- 
ance sheet,  225 ;  borro wings 
by,  225-6;  London,  com- 
pared with  joint-stock 
bank,  227. 

Discount  rate,  defined,  51;  of 
Bank  of  France,  excep- 
tional stability  of,  569-70 ; 
and  spread  between  long 
and  sight  exchange  rates, 
599-601. 

Discount  rate,  manipulation  of 
to  influence  the  gold  move- 
ment, 546-56 ;  mechanism 
of  action  of  same,  551-6; 
why  particularly  a  London 
remedy,  551-6;  by  Ger- 
many and  other  countries 
than  England,  556. 

Discount  for  cash,  less  common 
in  foreign  than  domestic 
commerce,  306-7. 


Discounts,  defined,  52-3;  as  as- 
sets of  bank,  58. 

Discounting  bills.  See  Buying 
rates. 

Dinar,  of  Servia,  484. 

Dishonor  of  negotiable  instru- 
ments, 33  et  seq. 

Distribution  of  gold,  interna- 
tional, theory  of,  618-23. 

Documents,  reasons  for  attach- 
ing to  bills,  99-100;  kinds 
of  attached,  101. 

"Documents,  cash  against,"  and 
methods  of  settlement, 
327-8. 

Documentary  instructions, 

117-8;  and  terms  of  sale, 
328-9;  documents  for  ac- 
ceptance, IIS;  for  pay- 
ment, 88,  118. 

Documentary  trade  bill,  98-130. 

Documentary  acceptance  bill, 
118. 

Documentary  payment  bill,  118 ; 
not  discounted  in  London, 
268-9;  recovery  of  funds 
laid  out  in,  391-6;  difficult}' 
in  determining  buying 
price  for,  391-2;  specula- 
tion and  investment  in, 
392-3;  bankers'  own  long 
bill  drawn  against,  393-4; 
selling  futures  against, 
394-5. 

Dollar  of  United  States,  history 
of  various  weights  of,  482. 

Dollar  credits,  134-5. 

Dollar  exchange,  the  question 
of,  624;  extent  of  develop- 
ment of,  dependent  on  New 
York  discount  market, 
626-7. 


SUBJECT  INDEX 


635 


Dollar  loan,  by  foreign  bank  in 
New  York,  359-64;  same 
illustrated,  360  et  seq.;  risk 
of  exchange  in,  361-3; 
character  of  gain  of  accept- 
ing bank,  362-3;  true 
lender  not  the  accepting 
bank,  363-4;  choice  be- 
tween dollar  and  sterling 
loan,  371-2. 

Domestic  exchange,  methods  of 
quoting,  73. 

Domicile  of  exchange,  84. 

Drachma,  Greek,  483. 

Draft,  20;  definition  of  term, 
20-1. 

Drawer's  liability,  29. 

Endorsement.  See  Indorse- 
ment. 

England ;  coins  of,  492 ;  govern- 
ment Currency  Notes,  495; 
legal  tender  in,  495-6;  mint 
and  bank  price  of  gold  in, 
502-7;  mint  pars  of,  485; 
money  notation  of,  90; 
paper  money  in,  492-5; 
"tolerance"  in,  496.  See 
London. 

England,  Bank  of.  See  Bank 
of  England. 

Exchange,  20;  denned,  1,  21;  as 
discount  on  a  bill  on  an- 
other place,  313;  in  the 
"colonial  clause,"  313; 
added  to  invoice,  317. 

Exchange  supply  and  demand, 
in  relation  to  commerce, 
67. 

Exchange  dealings,  general 
character  of,  62  et  seq.J 
classes    of    dealers    in    ex- 


change, 63-4 ;  facilities 
necessary  for,  191-2. 

Exchange,  methods  of  quoting, 
62  et  seq. 

Exchange  rates,  theory  of,  578- 
623. 

Explicit  interest,  53. 

Export,  the  special  art  of, 
325-6. 

Export  of  gold,  excessive,  natu- 
ral remedy  for,  620-3. 

Exportability  of  commodity 
money,  463-4. 

» 

Facilities  required  for  exchange 
business,  191-2. 

Farthing,  483. 

F.A.S.,  335. 

Federal  Bills  of  Lading  Act, 
103. 

Federal  Reserve  Banks,  354; 
relations  with  Bank  of 
England,    243-4. 

Federal  Reserve  Board,  459n. 

Fiat  money,  455,  456-8;  for- 
mal definition  of,  456;  na- 
ture of  considered,  457-8; 
contrasted  with  commodity 
money,  458-60;  propensity 
to  depreciate,  459-60;  non- 
exportability  of,  464. 

Finance;  meaning  of  "to 
finance,"  161-2,  379-80; 
financing  shipments  by 
bant  or  commercial  credit, 
160  et  seq.;  financing  by 
means  of  banker's  long 
bill,  379-80. 

Finance  bill,  367—9;  definition, 
380;  distinguished  from 
commercial  hill.  359;  ac- 
count   of    operation    with 


636 


SUBJECT  INDEX 


banker's  own  long  bill, 
368  -9;  interest  cost  of  loan 
by,  369  71 ;  drawn  to  carry 
borne  securities,  373-5; 
same,  computing  profii 
gained,  374-5;  banker's 
long  bill,  when  not  a 
finance  bill,  394. 

Fine  bullion,  mint  price  of, 
440-7;  in  the  United 
States,  498. 

-Floaters,"  221. 

"Floating  money,"  254. 

Florin,  of  Holland,  97. 

F.O.B.,  335. 

Foreign  balance,  190  et  seq. 

Foreign-bill  policy,  to  influence 
the  gold  movement,  573-4. 

Foreign  coin,  sale  of  to  United 
States  mint,  illustrated, 
500-1. 

Foreign  exchange,  defined,  1. 

Foreign  moneys,  direct  pur- 
chase and  sale  of,  472-3. 

Forward  or  arrival  discount 
rate,  255  et  seq. 

France.     See  Bank  of  France. 

France,  mint  and  bank  price  of 
gold  in.  509-13;  mint  pars 
of,  485-6;  rates  on,  in 
United  States,  92. 

Franc,  weight  of  gold,  483;  sil- 
ver 5  franc  piece  and  gold- 
premium  policy  of  Bank  of 
France,  564-5. 

Franco  Domicile,  335-6. 

Free  coinage,  437-40,  456; 
right  of,  defined,  438;  and 
quantity  of  money,  458-9. 

Fund,  formal  definition  of  term, 
404 ;  methods  of  transfer 
of  funds,  405;  direct  trans- 


fer    of,     404-8;     indirect 

transfer  of,  416-18;  direct 
transfer  of,  illustrated, 
407;  choice  between  meth- 
ods of  direct  transfer, 
406-8. 

Future  delivery,  exchange  for; 
dealings  in,  381-2;  opera- 
tions in  for  a  hedge,  382-4; 
buying,  when  a  pure  specu- 
lation on  long  side,  386; 
sale  of,  when  a  pure  specu- 
lation on  short  side,  389- 
90;  selling,  against  pur- 
chased documentary  pay- 
ment bills,  394-5;  sources 
of  supply  and  demand, 
395-6 ;  arbitrage  in,  424-5. 

Future  sum  and  present  price, 
39-42. 


Germany,  mint  and  bank  price 
of  gold  in,  513-16;  mint 
pars  of,  486;  rates  on,  in 
the  United  States,  95. 

Gold;  international  distribution 
of,  theory  of,  618-23;  pro- 
duction and  consumption 
of,  450 ;  purchasing  power 
of,  fluctuations  in,  451, 
462-3. 

Gold  bullion,  not  money,  5. 

Gold  coins;  of  England,  492; 
of  United  States,  486-7; 
same,  least  current  weight 
of,  491. 

Gold  export  and  import;  inter- 
est charge  in  connection 
with  exports,  526-7;  ex- 
port, New  York  to  London, 
practical    computations   of 


SUBJECT  INDEX 


637 


costs  and  proceeds,  423-30 ; 
harmfulness  of  export  dis- 
cussed, 544-5 ;  excessive 
export,  artificial  and  natu- 
ral remedies  for,  545-6, 
620-3;  import  by  New- 
York  from  London,  prac- 
tical computations  of  costs 
and  proceeds. 
See  also  Gold  movement 
and  Gold  shipments. 

Gold  movement ;  classification 
of  gold  movements,  517; 
special  banking  methods  of 
influencing,  544-6 ;  ma- 
nipulation of  the  discount 
rate  to  influence,  546- 
56;  mechanism  of  the  ef- 
fect .of  changes  in  the  dis- 
count rate.  551-6 ;  manipu- 
lation of  the  price  of  gold 
to  influence  the,  556-63; 
moral  suasion  to  prevent 
gold  export,  576-7;  Eng- 
lish and  American,  during 
the  panic  of  1007. 
See  aho  Gold  shipments. 

Gold-points,  522-3,  438;  vari- 
ability of,  522-3;  same, 
illustrated,  530,  535;  rela- 
tion to  mint  par,  542-4; 
and  foreign  price  of  gold, 
526-3. 

Gold-premium  policy  of  the 
Bank  of  France,  563-71; 
benefits  and  disadvantages 
of,  discussed,  570-1. 

Gold,  price  of;  mint  and  mar- 
ket price,  443-52;  market, 
448-50;  stability  of  latter. 
443-5;  contrasted  with 
purchasing     power,     452; 


mint  and  bank  price  in 
England,  502-7;  in  Lon- 
don market,  507-9;  mint 
and  bank  price  in  France, 
509-13;  terms  of  payment 
for  gold  by  the  Bank  of 
France,  512-13;  mint  and 
bank  price  in  Germany, 
513-16;  sale  of  bars  by 
Bank  of  England  illus- 
trated, 561-2;  sale  and  ex- 
change of  bars  by  the 
United  States  mints,  502; 
sale  of  United  States  gold 
coin  to  the  Bank  of  France 
illustrated,  512. 

Gold  shipments,  517-77;  for  a 
profit,  518-22;  at  a  loss, 
551n,  576;  regularly  made 
by  bankers  only,  518-19; 
general  relation  to  ex- 
change rates,  519-22;  in- 
terest cost  in,  discussed, 
536-9;  same,  variant  meth- 
ods of  computing,  539-41. 
See  also  Gold  movement 
and  Gold  export. 

Gold  standard ;  what  is  requi- 
site to  be  on  the.  431-2; 
quantity  of  standard 
money  determined  by  free 
play  of  private  interests, 
458-9. 

Gold-exchange  standard,  430; 
in  India,  457. 

Gold  standard,  the  "limping," 
432,  476-8. 

Grace,  days  of,  85. 

"drain    for   payment,"   88. 

Gratuitous  coinage,  -137—10. 

Great  Britain.  See  England 
and  London. 


SUBJECT  INDEX 


Greenback,  legal  tender  power 

of,  !n. 
Guilder  of  Holland,  97. 
Gulden  of  Holland,  97. 

Hedge,  defined,  382;  compared 

with  speculation,  381-2. 
Holder  in  due  course,  24. 
Home   money,    bill    on    foreign 

country  in,  275  et  seq. 
Hypothecation ;    certificate    of, 

107  et  seq.;  general  letter 

of,  108. 

Implicit  interest,  53. 

Incidental  costs,  allocation  of 
in  cases  of  export,  334  et 
seq. 

India,  British,  monetary  experi- 
ence of  1893-99,  456-7. 

Indirect  rate  quotations,  74. 

Indorsement,  26;  of  order  bill 
of  lading,  effect  of,  103-4. 

Indorsements,  kinds  of,  27;  as 
liability  in  English  bank 
statement. 

Indorser's  liability,  29. 
See  also  Recourse. 

Interest,  39-55 ;  rate  of  defined, 
51 ;  illustrative  problems, 
45  et  seq.;  contrasted  with 
discount,  43;  explicit  and 
implicit,  53;  as  "yield," 
53;  nominal  rate  of,  53. 

Interest,  exporter's  charge  for, 
when  entered  into  bill  of 
exchange,  306-10 ;  added 
to  invoice,  307. 

Interest  cost;  in  sterling  loan, 
366,  368-9;  further  dis- 
cussed,   369-71;     in    gold 


shipments  explained, 

536-9;  same,  methods  of 
computing,  539^11. 

Interest  realized,  in  investment 
in  exchange,  computing 
rate  of,  347-50;  same, 
356-8. 

Interest  on  bank  balances,  204. 

Interest-free  balances,   204. 

Interest-free  advances,  to  facili- 
tate gold  import,  571-3. 

Interior  banks,  exchange  busi- 
ness of  through  jobbers, 
341-2. 

Investment  in  exchange,  343- 
58;  contrasted  with  bor- 
rowing by  means  of  ex- 
change, 344;  method  of 
making,  344-7 ;  distin- 
guished from  making  of 
ordinary  foreign  loan,  345 ; 
technique  of,  346-7 ; 
prompt  presentment  for 
acceptance  still  necessary, 
347;  computing  rate  of  in- 
terest received  in,  347-50; 
speculation  on  sight  rate 
involved  in,  350-3;  effect 
of  variations  of  sight  rate 
on  rate  of  interest  realized, 
351,  356-8 ;  conditions 
favorable  and  unfavorable 
to,  352-3;  termination  of, 
prior  to  maturity,  353-8; 
foreign  bill  as  liquid  asset, 
354-5 ;  combined  with 
speculation  on  the  long 
side,  387-9;  in  documen- 
tary payment  bills,  392-3. 

Invoice;  with  documentary  bill, 
116 ;  consular  certified, 
116-17. 


SUBJECT  INDEX 


639 


Inspection  of  goods,  before  ac- 
ceptance of  bill,  333^i. 

Insurance  certificate,  106;  open 
policies,  107. 

International  distribution  of 
gold,  theory  of,  618-23. 

Irredeemable  paper,  quantity 
and  value  of,  457-8. 

Jevons'  definition  of  standard 
money  criticised,  455. 

Jobbing,  exchange,  341-2. 

Joint-account,  in  a  loan  by 
means  of  exchange,  373-7. 

Joint-stock  bank,  London,  207 
et  seq.;  specimen  statement 
of,  210 ;  functions  summar- 
ized, 216-17;  dealings  of 
in  foreign  exchange,  217. 

Lading.     See  Bill  of  lading. 

Latin  monetary  union,  483. 

Lawful  money,  definition  of,  6n. 

Legal  tender,  3,  6;  effect  of  re- 
jection of,  6-7;  reasons  for 
law  of,  8;  special  tender 
powers,  8;  gold  coin  clause 
in  money  contracts,  8,  9n; 
legal  tender  power  of 
standard  money,  456 ;  same, 
of  representative  moneys, 
476;  legal  tender  in  the 
United  States,  4,  8,  487-8 ; 
in  England,  495-6;  least 
current  weight  of  gold  coin 
in  the  United  States,  491. 

Letter  of  credit,  commercial, 
131  et  seq.;  specimen, 
13G-7;  provisions  analyzed, 
137-8;  recording  of  drafts 
under,    139;    contract    for, 


148  et  seq.;  advantages  of 

summarized,  167. 

See  also  Commercial  credit. 

Letter  of  credit,  traveler's, 
181-4. 

Letter  of  delegation,  318-21. 

Leva,  of  Bulgaria,  484. 

Liability  of  parties  to  negotia- 
ble instruments,  29  et  seq.; 
classification  of  parties  lia- 
ble on  bills  and  notes,  38n. 

Limping  gold  standard,  432, 
476-8;  in  France,  Ger- 
many, and  the  United 
States,  477;  and  gold-pre- 
mium policy  of  the  Bank 
of  France,  564. 

Liquid  asset,  foreign  bill  as, 
354-5. 

Lire,  of  Italy,  483. 

Literature  of  exchange,  note  on, 
191n. 

Loan  by  means  of  foreign  ex- 
change; general  nature  of, 
371-2;  dollar  loan  by  for- 
eign bank  in  New  York, 
359-64;  foreign,  in  local 
money,  365-7;  Ameriean, 
in  foreign  monev  capital, 
377. 

See  also  Borrowing  by 
means  of  exchange. 

Loans  by  bank;  their  limits, 
58-61;  as  assets,  58; 
proper  marshaling  of,  61. 

London  money  market ;  dealers 
in,   207   et    seq.;   interna 
tional    character    of,   230; 
group    of    money    rates    in, 

252;  money  rates  that  are 
based  on  the  bank  rate, 
250;  financing  of  non-Eng- 


640 


SUBJECT  INDEX 


lish  commerce  by,  103, 
303-4,  379-80;  method  of 
quoting  American  securi- 
ties, 427;  exchange  rates 
for  bills  on  the  colonies, 
311-12. 
See  also  England. 

London,  banking  in ;  acceptance 
houses,  208;  joint-stock 
banks,  207 ;  specimen  state- 
ment of  joint-stock  bank, 
210;  functions  of  same 
summarized,  216-17;  deal- 
ings of  in  foreign  ex- 
change, 217;  bill  brokers 
and  discount  houses,  218; 
forei.un  and  colonial  banks 
in,  227;  American  branch 
banks  in  London,  230 ;  five 
great  banks  of  London, 
231n. 

Long;  going  long  of  exchange, 
384—9 ;  outcome  of  opera- 
tion illustrated,  387-8 ; 
long  operation  involving 
investment  or  lending, 
387-9. 

Long  bills,  bankers';  buying 
rates  for,  258-65;  as 
finance  bills,  379-80;  when 
not  finance  bills,  394;  sale 
of,  and  speculation  on  the 
short  side,  390-1;  drawing 
of  against  documentary 
payment  bills,   393^4. 

Long  rates,  spread  between  and 
sight  rate,  theory  of,  599- 
601. 


Mark,  of  Finland,  484;  of  Ger- 
many, 484. 


Market  and  coining  values  of 
token  bullions,  468-71. 

Market  price  of  gold,  443-52, 
4  18-50;  stability  of, 
443-5;  relation  to  mint 
price,  448-50. 
See  also  Price  of  gold  and 
Mint  price. 

Means  of  payment,  1-21,  2-5; 
chief  in  the  United  States, 
4. 

Melting  gold  coin,  and  market 
price  of  gold,  449 ;  lawful- 
ness of  melting,  448n. 

Metric  and  troy  weight,  479-81. 

Minor  coin,  legal  tender  power 
of,  4n. 

Mint  (U.  S.)  ;  charges  levied  by, 
498-9 ;  computation  of 
charge  for  copper  illus- 
trated, 500-1;  terms  of 
payment  by,  for  bullion, 
501-2;  sale  and  exchange 
of  gold  bars  by,  502;  pur- 
chase of  foreign  coin  by, 
illustrated,  500-1. 
See  also  Coinage,  Price  of 
gold,  Tolerance. 

Mint  price  of  gold,  443-52, 
445-6;  how  fixed  by  stat- 
ute, 445-6;  basis  price  of 
fine  bullion,  446-7;  in  the 
United  States,  497-502;  in 
England,  502-7;  in  France, 
509-13;  in  Germany,  513- 
16. 

See  also  Price  of  gold  and 
Market  price  of  gold. 

Mint  par  of  exchange,  432-5; 
defined,  77,  432;  chief 
propositions  concerning, 
432-5;  tolerance  and,  433; 


SUBJECT  INDEX 


641 


seigiiorage  and  brassage 
and,  434 ;  distinguished 
from  an  actual  value, 
435-7;  distinguished  from 
an  arbitrated  par,  401-2; 
and  price  of  foreign  coin, 
435-6 ;  and  exchange  rates, 
436-7;  legally  fixed  char- 
acter of,  437;  tables  of 
mint  pars,  485-6;  relation 
to  gold  points,  542-4. 

Money,  2;  definition,  3;  forms 
of,  in  the  United  States,  4; 
forms  of  in  a  modern  coun- 
try, 454;  standard  money, 
452-64;  quantity  and  value 
of  money,  460-2;  repre- 
sentative money,  465-78 ; 
token  money,  465. 
See  also  Fiat  and  Com- 
modity money. 

Money  dealers  in  London,  207. 

Money  rates,  group  of  in  Lon- 
don, 252. 

Monetary  standards,  the  sev- 
eral, 429-32. 

Monetary  systems  of  the  lead- 
ing countries,  479-516. 

Moral  suasion  to  prevent  gold 
export,  576-7. 

Morgan-Belmont  syndicate  of 
1896,  519. 

Negotiability,  22  et  seq. 

Negotiable  instruments;  de- 
fenses against  payment  on, 
24 ;  liability  of  parties,  29- 
38;  classification  of  parties 
liable,  30,  38n;  vendor's 
warranties,  36;  conditions 
of  recourse,  32  et  seq.;  pro- 
test, 35. 


Negotiable  instruments,  Uni- 
form Law  of,  cited,  12n, 
16n,  18n,  20n,  24n,  30n, 
32n,  33n,  128n. 

Negotiation,  26-8. 

Nominal  interest,  53. 

Nominal  rates,  82-4:. 

Nominal,  bullion,  and  actual 
values  of  token  moneys, 
465-8. 

Note,  the  promissory,  17-19; 
legal  definition  of,  18;  uses 
of,  18-19;  interest-bearing 
and  non-interest-bearing 
contrasted,  41-2. 
See  also  Bill  and  Negotia- 
ble instruments. 

Notification  of  real  consignee, 
104. 

Open  account,  sales  on,  and  re- 
mittance by  importer,  320. 

"Order"  bill  of  lading,  103. 

Overdraft  rate,  London,  and 
bank  rate,  251. 

Par    of    exchange.     See    Mint 

par. 
Parity    of   a    pair    of   mutual 

rates,  and  arbitrage,  611- 

13. 
Parity  of  representative  money, 

467. 
Partial  deliveries  and  payments 

on  D.  P.  bills,  109;  same, 

illustrated,  126. 
Peel  Act,  and  Bank  of  England 

note,  232-3. 
Pence,  483. 
Percentages,  English  method  of 

writing,  223-4. 
Peseta,  of  Spain,  484. 


042 


SUBJECT  INDEX 


Peso,  of  Argentine,  484. 

Philippine  silver  certificate, 
405  and  note. 

Point,  in  the  exchange  market, 
80. 

Post-remittance,  bank,  188. 

Posted  rates,  82-4. 

Pound  sterling,  90,  482.  See 
Sterling. 

Power  of  sale,  over  collateral, 
110,  153. 

Premium  and  discount  method 
of  quoting  exchange  rates, 
73. 

Premium   on  gold,   in   France, 
technical  nature  of,  misun- 
derstood, 505. 
See  Gold-premium  policy, 
etc. 

Prepayment  of  D.  P.  bills  un- 
der rebate,  111,  119  et  seq.; 
prepayment  rate  of  dis- 
count, 111;  reasons  for 
prepayment,  120;  prepay- 
ment illustrated,  123  et 
seq.;  prepayment  on  com- 
mercial credit,  160. 

Present  price  and  future  sum, 
69. 

Presentment,  of  negotiable  in- 
struments, 31-2. 

Presentment  for  acceptance 
withheld  for  inspection  of 
goods,  333-4. 

Price  of  gold;  defined  and  dis- 
cussed, 443-4 ;  maximum 
range  of  variation  of,  in 
London,  443,  558-9;  inde- 
pendence of  gold  produc- 
tion, 444-5;  abrasion  of 
coin  in  relation  to,  449; 
mint  price  in  the  United 


States,  497 ;  mint  and  bank 
price  in  England,  502-7; 
and  gold-points,  502-3; 
manipulation  of  to  influ- 
ence the  gold  movement, 
550-03 ;  gold-premium  pol- 
icy of  the  Bank  of  France, 
563-71. 

See  also  Mint  price  of  gold 
and  Market  price  of  gold. 

Private  banks,  international, 
231. 

Protest,  of  bill  of  exchange  or 
note,  35. 

Purchasing  power  of  gold,  his- 
tory of  fluctuations  of, 
462-3. 

Quantity  of  money;  and  free 
coinage,  458-9;  and  its 
value,  460-2. 

Quantity  theory  of  the  value  of 
money,  460-2;  significance 
of,  461-2;  involved  in  the 
received  theory  of  interna- 
tional distribution  of  spe- 
cie, 620. 

Quotation  of  rates,  methods  of, 
73  et  seq.;  quotation  of 
sterling  in  New  York,  91. 

Rate  of  discount,  defined,  44, 
51 ;  rebate  rate  of  discount, 
111,  119. 

See  also  Discount  and  Dis- 
count rate. 

Rate   of   interest,   defined,   45, 
51. 
See  also  Interest. 

Rate  on  bankers'  balances  in 
London  and  Bank  of  Eng- 
land rate,  251. 


SUBJECT  INDEX 


643 


Rates  of  exchange,  62-97; 
methods  of  quoting,  73; 
specimen  market  reports, 
74;  posted  and  nominal, 
82-4. 

Rebate;  of  "interest,"  121;  the 
rebate  rate,  119-22. 
See  Prepayment. 

Rebate  on  bills,  as  item  in  Eng- 
lish bank  statement,  213. 

Recourse,  on  parties  secondar- 
ily liable,  conditions  of, 
32  et  seq.;  indorsement 
without,  28-9;  right  of, 
and  conditional  acceptance, 
114-16 ;  practical  nature  of 
right  of  recourse,  176-9, 
332;  right  of  recourse  on 
draft  under  commercial 
credit,  177-8. 

Redemption  rights  of  moneys 
in  the  United  States,  489. 

Redeemable  money,  453. 

Rediscount,  defined,  52. 
See  Discount. 

Rediscount  at  Bank  of  Eng- 
land in  times  of  stringency, 
244-9. 

"Refinancing"  in  foreign  trade, 
321-5;  illustration  of,  and 
outcome  to  exporter,  323-4. 

Reichsbank,  German ;  price  of 
gold  at,  513-16 ;  discount 
rate  of,  and  gold  movement, 
556;  foreign-bill  policy  of, 
to  influence  the  gold  move- 
ment, 574. 

Remittance  by  buyer,  320. 

Representative  money,  465-78, 
also  453-5;  generally  non- 
exportable  character  of, 
471-4;    need    of    limiting 


bullion  contents  of,  473^; 
system  of  indirect  redemp- 
tion of,  475-6;  limitation 
of  legal  tender  power  of, 
476. 

Reserve,  bank,  57;  effects  of 
lending  upon,  59-60;  in 
English  sense,  211. 

Reserved  capital,  of  London 
joint-stock  banks,  210-11. 

"Rest"  of  the  Bank  of  England, 
211. 

Retirement  rate  of  discount, 
111,  119,  122;  customary 
retirement  rates  in  various 
countries,  122-3;  London, 
and  bank  rate,  251. 
See  Prepayment. 

Retirement,  effect  of  privilege 
of,  on  selling  price  of  bill, 
391-2. 

Risk  of  exchange,  defined,  164; 
illustration  of,  340 ;  in  con- 
nection with  commercial 
credit,  164;  and  the  draft 
for  home  money,  276,  279- 
80;  and  draft  in  money  of 
a  third  country,  288;  spe- 
cial agreements  covering, 
295-6 ;  losses  of  Americans 
on  sterling  after  outbreak 
of  war,  289;  risks  of  ex- 
change and  investment  in 
exchange,  350-3;  and  the 
dollar  loan,  361-3;  and  the 
sterling  loan,  366-7. 

Risk,  banker's,  nature  of  under 
the  commercial  credit,  177. 

Risk  of  goods,  under  the  com- 
mercial credit,  149-50. 

Rule  of  equal  sales  and  pur- 
chases, 198,  260,  271. 


(ill 


SUBJECT  INDEX 


Rupee,  of  British  India,  as  fiat 
and  as  representative 
money,  456-7. 

Sale,  power  of,  over  collateral, 
110,  153;  terms  of,  and 
methods  of  settlement, 
326-9. 

Sales  and  purchases,  rule  of 
equal,  198,  260,  271. 

Security,  personal  and  collat- 
eral, 85-6. 

Seigniorage,  439;  from  coinage 
on  government  account, 
469;  seigniorage  and  bras- 
sage and  the  mint  par,  434. 

Sets,  bills  in,  101-2. 

Settlement,  international,  use  of 
bill  in,  illustrated,  69  et 
seq.;  services  of  banker  in, 
71-2;  methods  of,  sum- 
marized, 325-36 ;  same, 
conspectus  of,  327-9. 

Shilling,  90,  483. 

Short  of  exchange,  going, 
385-6,  389-91. 

Sight  rate,  as  basis  of  other 
rates,  259,  274. 

Silver,  two  coining  values  of, 
in  the  United  States,  470; 
coining  values  of  in  differ- 
ent countries,  471. 

Silver  dollar,  American,  legal 
tender  power  of,  4n;  sys- 
tem of  indirect  redemption 
of,  476n. 

Silver,  subsidiary,  in  the  United 
States,  legal  tender  powers 
of,  4n. 

South  Africa,  bills  on  with  the 
"colonial  clause,"  310 ; 
London  rates  on,   311-12. 


South  and  Central  America,  in- 
structions for  drawing  on, 
304-6,  334n. 

Specie  shipments,  517-77. 

See    Gold    movement    and 
Gold  shipments. 

Speculation;  definition  of,  381; 
outright  and  incidental, 
382 ;  avoidance  of,  through 
arrival  discount  rates, 
255-6;  involved  in  invest- 
ments in  exchange,  350-3; 
in  connection  with  D.  P. 
bills,  392-3 ;  purposeful 
speculation  in  exchange, 
381-96;  going  long  on  ex- 
change, 384-9 ;  going  short, 
385-6. 

"Spread";  theory  of  the  sev- 
eral spreads,  596-9;  be- 
tween local  and  foreign 
money  rate,  and  finance 
bills/ 369-72. 

Stamp  taxes  on  bills,  256. 

Standard  bullion,  440-2;  charge 
for  standardizing,  441 ; 
mint  price  of,  445-6;  same, 
in  the  United  States,  497-8. 
See  Bullion  value. 

Standard  money,  452-64;  defi- 
nition of,  429,  454-5;  ap- 
proved characteristics  of, 
455-6 ;  commodity  and  fiat, 
456-8;  in  what  sense  value 
of,  is  determined  by  law, 
459. 

Standard  units  of  value,  in  four 
chief  countries,  481^4. 

Standards,  monetary,  the  sev- 
eral, 429-32. 

Sterling  bill ;  schedule  of  stamp 
taxes  on  sterling  bills,  257 ; 


SUBJECT  INDEX 


645 


drawn  from  the  United 
States  on  outlying  coun- 
tries, reasons  for  the  past 
use  of,  299-300;  drawn  in 
United  States  on  Latin 
America  and  the  Far  East, 
285;  on  Latin  America, 
customary  method  of  de- 
termining face  value, 
296-7 ;  reasons  for  long  re- 
turn bill,  300-2;  losses  of 
Americans  on,  after  out- 
break of  war,  289. 

Sterling  credit,  134;  American 
bank's  issue  of,  135;  risk 
of  exchange  in  connection 
with,  illustrated,  165;  how 
London  finances  commerce 
under,  163;  traveler's  ster- 
ling credits,  182-3. 

Sterling  loan,  365-7;  in  New 
York  illustrated,  365-6 ;  in- 
terest cost  of,  to  borrower, 
366;  risk  of  exchange  in, 
366-7;  character  of  gain 
of  accepting  bank,  367 ; 
variant  form  of,  367-9; 
choice  between  and  dollar 
loan,  371-2. 

Sterling  mint  pars,  485. 

Sterling  money  notation,  90. 

Sterling,  pound,  482. 

Sterling  rates  in  United  States, 
90;  ordinary  range  of  fluc- 
tuation of,  92. 

"Straight"  bill  of  lading,  103. 

Subsidiary  silver,  legal  tender 
power  of  in  the  United 
States,  4n. 

Supplemental  fractions,  in  cer- 
tain New  York  foreign 
rates,  94,  96. 


Supply  and  demand,  exchange; 

in    relation    to    commerce, 

67 ;    sources    of,    588-96 ; 

general     theory     of,     and 

rates,  578-88. 
Surrender  of  goods  by  banker 

to  importer,  various  plans 

for,  156  et  seq. 


Telegraphic  transfer.  See  Ca- 
ble and  Cable  rate. 

Terms  of  sale,  326-7 ;  and  meth- 
ods of  settlement  summar- 
ized, 325-36 ;  conspectus 
of  terms  of  sale,  327-9. 

"Through"  bill  of  lading,  105. 

Token  bullions,  coining  and 
market  values  of,  468-71. 

Token  coin,  need  of  limiting 
bullion  contents  of,  473-5. 

Token  money,  465;  system  of 
indirect  redemption  of, 
475-6;  features  of  a  per- 
fected system  of,  474-6. 

Tolerance ;  defined,  489-91 ;  in 
the  United  States,  489-91 ; 
in  gross  weight  of  new  gold 
coin,  491 ;  in  England,  496 ; 
and  the  mint  par,  433;  re- 
lation to  market  price  of 
gold,  509. 

Trade  bill,  98  et  seq. 

Trade  paper,  definition  of,  lOn. 

Transfer  of  funds,  methods  of 
direct,  404-8 ;  indirect, 
416-18. 

Traveler's  cheque,  185  et  seq.; 
letter  of  credit,  181. 

Troy  and  metric  weight,  479-81. 

True  discount,  53. 

Trust  receipt,  154;  use  of  illus- 


R46 


SUBJECT  INDEX 


trated,    157-8 ;     specimen, 
158-9. 

Uniform  Negotiable  Instru- 
ments Law,  cited,  in  notes, 
12,  16,  18,  20,  24,  30,  32, 
33,  128. 

United  States;  coins  of,  486-7; 
least  current  weight  of  gold 
coin,  491;  legal  tender  in, 
487-8;  mint  pars  of,  485, 
77-8;  mint  price  of  gold 
in,  497-502;  redemption 
rights  of  money  in,  489; 
"tolerance"  in,  489-91. 

Units  of  value,  in  four  leading 
countries,  481-4. 

Usance,  156n. 


Value  of  gold,  in  economic 
sense,  451. 

Value  of  money,  fluctuations  of 
in  history,  462-3. 

Value  of  money,  in  what  sense 
determined  by  law,  459. 

Value  of  money  and  its  quan- 
tity, 460-2. 

"Value  on,"  137n. 

Vendor's  warranties,  on  bills 
and  notes,  36. 


Warehousing  by  banker,  112- 
13. 

Yield,   in   sense   of  investment 
rate  of  interest,  53. 


AUTHORITIES  MENTIONED  OR  CITED 


Andrew,  A.  P.,  3n. 
Arnaune,  Aug.,  566. 
Arnold,  John  J.,  119n. 
Avebury,  Lord,  237. 
Brooks,  H.  K.,  135,  151n,  158n, 

184n,  187n,  191n. 
Brown,  H.  G.,  192n. 
Clare,  George,  68n,  190n,  191n, 

207n,    221n,    232n,    281n, 

353n. 
Clark,  W.  A.,  Graham,  336n. 
Deutsch,  H.,  191n,  496n. 
Duguid,  Charles,  208n. 
Easton,  H.  T.,  191n,  207n,  480n. 
Escher,  F.,  158,  191n,  380n. 
Fisher,  Irving,  53n,  452n,  461n, 

462,  623. 
Fredrick,  Leopold,  627. 
Fuerst,  Max.,  510n. 
Goschen,  George  J.,  192n. 
Gow,  Charles,  147,  237,  242. 
Gregory,  G.  E.,  527n. 
Harding,  Fred  C,  297. 
Haupt,  0.,  191n. 
Jevons,  W.  S.,  455. 
Johnson,  J.  F.,  456n,  461n. 
Kaufmann,  E.,  191n,  511n. 
Kemmerer,  E.  W.,  452n. 
Knapp,  G.  F.,  457n. 
Laughlin,    J.    L.,    462n,    474, 

476n. 


Margraff,  Anthony,  116n,  117n, 

150n,    158n,     183n,    184n, 

191n,  251n,  346n,  353,  394. 
Mises,  L.  van,  575n. 
Mitchell,  W.  C,  452n. 
Norman,  J.  H.,  191n. 
Norton,    C.    P.,    on    Bills    and 

Notes,  38n. 
Noyes,  A.  D.,  476n. 
Odell,  Ralph  M.,  337n. 
Palgrave,  R,  H.,  Inglis,  238n, 

248n,  569. 
Pallain,  M.  (Governor  of  Bank 

of  France),  567. 
Pierson,  N.  G.,  601n. 
Ricardo,  David,  618  et  seq. 
Roberts,  Geo.  E.,  502n. 
Rosendorff,  R.,  566,  570n. 
Schuster,  Sir  Felix,  146,  218n, 

238n,  244n,  250n. 
Spaulding,  W.  F.,  192n,  325n. 
Straker,  F.,  207n,  222n. 
Swoboda,  Otto,  190n,  510n,  513, 

567. 
Tate,  Win,  418n,  496n. 
Walker,  Francis  A.,  3n. 
Walsh,  C.  M.,  452n. 
Withers,  Hartley,   192n,  207n, 

218n,  567,  576. 
Wolff,  Archibald  J.,  123n,  30  In 

(7) 


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LIBRARY 


3  1 


58  01218  6432 


. 


HG 
3851 
W58f 


CO 


r\ 


AA    001  145  950    o 


